59 23582981 Management Accounting Ebook

A-PDF MERGER DEMO
MANAGEMENT
ACCOUNTING
Prof. Satish Inamdar

M.Com., L.L.B., F.C.A., Gr.C.W.A., A.C.S.
(FOR PRIVATE CIRCULATION ONLY)
Published by
Symbiosis Center for Distance Learning,

Pune.
Symbiosis Center for Distance Learning (SCDL)

No part of this book may be reproduced or copied or transmitted
in any form without prior permission of the publishers.
2005 Batch
PREFACE
Failure of majority of the industrial undertakings is mainly attributable to the lack of awareness
about the wrong financial decisions affecting the business, particularly accounting and costing
decisions. The crux of wrong financial decisions is that the implications of the wrong financial
decisions are not realized immediately, and by the time they are realized, it is too late. As
such, it is most important to take proper financial decisions at proper point of time. For this,
clear understanding of basic financial and costing principles is a must for everybody.
My objective of writing this book is to introduce the basic concept of financial and cost accounting
in the simplest possible language to the readers. I have attempted to explain the basic concepts
with the help of examples and illustrations. Good number of problems have been incorporated
for self-study.
I am thankful to Symbiosis Center for Distance Learning and particularly to Ms. Swati Chaudhary,
Director, SCDL, for providing me this opportunity to reach out to a very wide spectrum of
readership.
All the efforts have been done to make the text free of errors. Still, I dont rule out the possibility
of some omissions. I will be obliged if such omissions can be pointed out and intimated so
that necessary modifications can be done in the subsequent editions.
Prof. Satish Inamdar

5, Brahma Residency, Bhusari Colony,
Kothrud, Pune 411 038
Tel : (020) 528 2058 / 528 5749
Email : sminamdar@yahoo.com
ABOUT THE AUTHOR

Prof. Satish Inamdar is holding a Masters Degree in Commerce and Bachelors Degree in
Law. He is fellow Member of the Institute of Chartered Accountants of India, Graduate Member
of The Institute of Cost & Works Accountants of India and Associate Member of The Institute
of Company Secretaries of India. He is associated with the industry for the last two decades
in various senior capacities. For the past fifteen years, he is associated with Symbiosis
Institute of Business Management as a Faculty of Finance. He has conducted Management
Development Programmes and Executive Development Programmes for various private sector
and public sector organisations. He has authored three books on the subjects like Cost &
Management Accounting and Financial Management. He is Charter Member of Rotary Club
of Pune, Kothrud.
CONTENTS
Chapter
No.
TITLE
Introduction
a) Streams of Accounting - Financial, Cost and
Management
b) Definition, Objects and Scope of Management
Accounting
c)
d)
a)
b)
c)
Principals, Convention and Concepts of Accounting

Systems of Accounting
Types of Expenditure
d)
e)
Glossary of Terms Used in Financial Accounting

Double Entry System of Accounting
f)
Depreciation Accounting
Process of Accounting
a) Journalising, Posting, Control Ledgers, Balancing of
Accounts, Preparation of Final Accounts
b) Illustration with Solutions
15
35
Problems for Students to Solve
Bank Reconciliation Statement

a) Preparation of Bank Reconciliation Statement
b)
c)
Disadvantages/Limitations of Management Accounting

Comparison with Financial and Cost Accounting
Basics of Financial Accounting
c)
Page
No.
101
Illustration with Solution

Rectification of Errors
a)
b)
Types of Errors
Effect of Errors on Trial Balance
c)
Illustration with Solutions and Problems for

Students to Solve
129
Chapter
No.
TITLE
Cost Accountancy (Basic Concepts and Principles)

a) Introduction
b)
c)
Concept of Cost Centre

Special Types of Cost
d)
Illustration of Costing System
Elements of Costs
a) Cost Sheet / Cost Statement
b)
c)
c)
147
155
Illustrative Problems with Solutions

Material Cost
a) Direct / Indirect Material
b)
Page
No.
183
Procurement / Issue of Material, P.O., GRN, MRN,

Bin Card
Methods of Valuation of Stores, Receipts / Issues
d)
e)
f)
Techniques of Inventory Control

Illustrations with Solutions
ABC Analysis, Bill of Material, Perpetual Inventory
System
g)
h)
Illustrative Problems with Solution

Labour Cost
a)
b)
c)
Time Keeping Methods

Time Booking, Time Sheet, Job Card
Methods of Remuneration, Time Rate, Piece Rate,
Various Bonus/Incentive Systems
d)
e)
Important Terms in Case of Labour Cost

f)
247
Chapter
No.
10
11
12
TITLE
Overhead Cost
a) Elementwise and Functionwise Classification
b)
Procedure for Charging the Overheads

- Distribution Methods
c)
d)
Absorption of Overheads
Machine Hour Rate
e)
f)
Under/Over Absorption
g)
Marginal Costing
a) The Concept, Basic Assumption, Features
b)
c)
Form of Operating Statement

Basic Concepts of Marginal Costing, Contribution,
d)
Profit Volume Ratio, Bank Even Point, Margin of Safety

Illustration with Solutions
e)
f)
g)
Cost, Volume, Profit Relationship

Product Profitability
Limitations of Marginal Costing
h)
i)
Illustrations with Solutions

Budgetary Control
a)
b)
Budgets and Budgetary Control, Advantages, pre-requisites

Types of Budgets
c)
d)
Fixed and Flexible Budget

e)
Page
No.
289
343
437
Chapter
No.
13
14
TITLE
Standard Costing
a)
b)
Concept of Standard Cost and Standard Costing

Advantages, Limitations
c)
d)
Standard Costing Compared with Budgetary Control

Preliminaries for Establishing Standard Costing System
e)
f)
Basic Standards
Reporting and Analysis of Variances
g)
h)
Illustrations and Solutions

Uniform Costing
a)
b)
Page
No.
493
547
Scope
Requisites, Advantage, Disadvantages
Suggested Reading
553
Assignment Question Bank
555
Chapter 1
INTRODUCTION
A business is an activity carried out with the intention of earning the profits. A person carrying
out the business is interested in knowing basically two facts about his business (a)
What is the result of operations of the business activity? In other words, whether the
business has resulted into the profit or loss? Excess of revenue over the expenses will
be in the form of profits whereas excess of expenditure over the revenue will be in the
form of loss.
(b)
Where the business stands in financial terms at any given point of time.
Providing the answers to the above questions is not possible unless the transactions relating
to the business are recorded in a systematic manner. Here the process of accounting comes
into the picture. According to American Institute of Certified Public Accountants, Accounting
is the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which are of a financial character and interpreting the results
thereof. The process of recording the business transactions in a defined set of records, which
in technical words are called as Books of Accounts, is referred to as Book Keeping. Accounting
refers to the process of analyzing and interpreting the information already recorded in the
books of accounts with the ultimate intention of answering the above stated questions.
This intention is satisfied by preparing what are called as Financial Statements. The financial
statements prepared by the organization are basically in two forms(a)
Profitability Statement, which is the answer to the first question i. e, what is the result of
operations of the business activity. Thus, profitability statement indicates the amount of
profit earned or the amount of loss incurred.
(b)
Balance Sheet, which is the answer to the second question i.e. where the business
stands in financial terms at any given point of time. Thus, balance sheet indicates the
financial status of the business at any given point time in terms of its assets and liabilities.
Introduction
The nature of these financial statements is discussed in details in the following pages.
Thus, the process of book keeping is more procedural and clerical in nature while the process
of accounting is more managerial in nature. As such, the job of book keeping is entrusted to
junior level employees, whereas the job of accounting needs more professional expertise.
STREAMS OF ACCOUNTING
The process of Accounting gets split into three streams 1.
Financial Accounting
2.
Cost Accounting
3.
Management Accounting
Let us discuss the nature of these three streams of accounting in details.

Financial Accounting is the process .of systematic recording of the business transactions in
the various books of accounts maintained by the organization with the ultimate intention of
preparing the financial statements there from. These financial statements are basically in two
forms. One, Profitability Statement which indicates the result of operations carried out by the
organization during a given period of time and second Balance Sheet which indicates the
state of affairs of the organization at any given point of time in terms of its assets and liabilities.
This nature of Financial Accounting indicates following characteristic features of Financial
Accounting -
(a)
Financial Accounting considers those transactions which can be expressed in terms of

money. All those transactions which can not be expressed in terms of money, howsoever
important they may be from business point of view, find no place in financial accounting
and hence in financial statements. E.g. Assuming that the business of an organization
is such that it is likely to be injurious to the health of local community. As such, there is
a strong opposition from the local community for the companys carrying on the business
at that location. This opposition is something which can not be expressed in terms of
money and hence finds no place in financial accounting and hence in financial statements
though, it is affecting the business operations of the organization to a very great extent.
(b)
Financial Accounting is referred to as Historical form of accounting. In other words,

financial accounting is concerned with recording of transactions which have already
taken place. No futuristic transactions and events, howsoever important and significant
they may be from business point of view. find any place in financial accounting and
hence in financial statements.
(c)
In practical circumstances Financial Accounting is more or less a legal requirement. In

case of certain organizations like Company form of organization, Banks, Insurance
Companies etc., not only it is necessary to maintain the financial accounting records
and prepare the financial statements there from, but it is obligatory to get these financial
statements audited also by an independent Chartered Accountant. In some cases, there
may not be direct legal requirement to prepare the financial statements, but indirectly it
is necessary to prepare the financial statements. E.g. If a partnership firm wants to file
its Income Tax Return as per the provisions of Income tax Act, 1961, preparation of
financial statements is a must to ascertain the profits.
(d)
Financial Accounting is meant for those people who are external to the organization. In
other words, financial accounting is basically meant for those people who are not a part
of decision-making process regarding the organization. This class of people may consist
of the people like investors, customers, suppliers, banks, financial institutions etc.
(e)
The information available from Financial Accounting, i.e. financial statement, is available
at a delayed point of time. E.g. Balance Sheets as on 31st March 2002 is available after
31st March 2002 is over. The various legal provisions also allow sufficient time lag for the
preparation of financial statements. For decision-making purposes, immediate availability
of financial data is a prerequisite which is not satisfied by financial accounting. In this
sense, financial accounting has the limitation. Further, as sufficient time is allowed for
the preparation of financial statements, they are expected to be accurate.
(f)
Financial Accounting discloses the financial performance and financial status of the
business as a whole. It does not indicate the details about the individual department or
job or process inside the organization, the information which is more significant from
decision-making point of view. In this sense, financial accounting has the limitation.
(g)
Financial statements are essentially interim reports and cannot be the final ones. E.g. In
order to understand the correct profitability and correct position of the assets and liabilities
of an organization, it will be necessary to stop the business operations, dispose off all
the assets of the organization and liquidate all the liabilities. Obviously it is not feasible
and practicable. In order to prepare the financial statements for a specific period, it may
be necessary to cut off various transactions involving costs and incomes at the date of
closing the accounts. This may involve personal judgements. Various policies and
principles are required to be formulated and followed consistently for such cutting off of
incomes and costs.
(h)
As the going concern principle is followed while preparing the financial statements, the
various assets and liabilities are shown at the historical prices which may not necessarily
represent the current market prices or the liquidation prices. This may affect profitability
Introduction
also due to incorrect provision for depreciation on assets. This problem may be more
critical during the periods of extreme inflation or depression.
(i)
The process of Financial Accounting gets largely affected due to the various accounting
policies followed by the accountants. Even though, attempts are being made to bring in
the uniformity in the various accounting policies followed by the accountants, still the
accounting policies may differ from organization to organization. These accounting policies
may differ basically in two fields :
l
Valuation of Inventory
Calculation of Depreciation
The effect of these different accounting polices is discussed in the following chapters.
Cost Accounting
Cost accounting is the process of classifying and recording of the expenditure in a systematic
manner with the intention of ascertaining the cost of a cost centre with the intention of controlling
the cost. The Institute of Cost and Management Accountants, London has defined Cost
Accounting as the application of costing and cost accounting principles, methods and
techniques to the science, art and practice of cost control and the ascertainment of profitability
as well as the presentation of information for the purpose of managerial decision making. The
above description of Cost Accounting reveals the following characteristic features of Cost
Accounting (a)
Cost Accounting views the organization from the angle of individual components of the
organization like department or job or process etc. Cost Accounting is interested in
ascertaining the profitability of these individual components of the organization.
(b)
Cost Accounting is operated with basically three objectives -
(c)
Ascertainment of cost and profitability with the help of various principles, methods
and techniques.
Cost Control - This indicates the process of controlling the costs of operating the
business.
Presentation of information to enable the managerial decision-making.
Cost Accounting is meant for those people who are internal to the organization. In other
words, Cost Accounting is meant for those people who are a part of decision-making
process of the organization. The people who are external to the organization do not have
any access to the cost accounting records. In fact the basic objective of cost accounting
is to facilitate professional decision-making process on the part of managers.
(d)
Cost Accounting is not a legal requirement. Maintenance of cost accounting records is

not mandatory. However, maintenance of cost accounting records may be a legal
requirement in some exceptional cases. Section 209 (1) (d) if the Companies Act, 1956,
makes it mandatory for companies falling under certain class of industries to maintain
cost accounting records and also get them audited from an independent Cost Accountant
(which is technically referred to as Cost Audit).
(e)
Cost Accounting does not necessarily restrict itself to the historical transactions or
historical events. Future transactions or events may find the place in cost accounting. In
fact, each and every transaction, whether past or future, which is likely to have an impact
on the business is of concern to the cost accounting.
(f)
As Cost Accounting is supposed to facilitate professional decision making on the part of

manager, immediate availability of data is the prerequisite of cost accounting. As such,
accuracy is not insisted upon by cost accounting to the extent of hundred percent.
Management Accounting is the process of analysis and interpretation of financial data collected
with the help of financial accounting and cost accounting with the ultimate intention to draw
certain conclusions therefrom in order to assist the management in the process of decisionmaking.
Emergence of Management Accounting
In the olden days, when size of business operations was small and the complexities involved
in the same were limited, financial accounting was considered to be sufficient. Financial
Accounting ultimately aims at preparing financial statements which are basically in two forms.
(1)
Profit and Loss statement which is a period statement and relates to a certain period,
usually one year. This tells about the result of operations, either profit or loss, arising out
of the conduct of business operations during that period.
(2)
Balance Sheet which is a position statement and relates to a particular point of time.
This tells about the various properties held by the business (termed as assets) and
obligations accepted by the business (termed as liabilities) as on a particular date.
The preparation of these financial statements was considered to be sufficient to serve the
requirements of all the interested parties, both outsiders as well as insiders.
However, due to the increasing size and complexities of the business operations and specifically
due to the segregation of ownership and management, only financial accounting was realised
to be insufficient. This was specifically due to certain limitations of financial accounting.
Introduction
(a)
Financial accounting considers only those transactions which may be expressed in

financial terms, either fully or at least partially. However, it ignores the fact that there may
be other types of non-financial transactions which may have a bearing on business
operations, e.g.. Prestige of business, credit standing of business, efficiency and loyalty
of employees, efficiency and intensity of management etc.
(b)
Financial accounting deals with recording of the past events and as such it is the postmortem record of business transactions. For taking correct decisions regarding the
business, the management may need, not only the past details but also the future
events, and future events are not the subject matter of financial accounting.
As such, financial accounting and preparation of financial statements therefrom is no longer

considered to be sufficient for successful and smooth running of business. The analysis and
interpretation of data available from financial accounting is also considered to be necessary
which may not be directly available from financial accounting itself. Here comes into the
picture Management Accounting. Management Accounting deals with, the analysis and
interpretation of financial data with the ultimate intention to draw certain conclusions therefrom,
in order to assist the management in the process of decision-making. To conclude, it may be
said that the role of management accounting has emerged due to the shortcomings of financial
accounting.
Definition of Management Accounting
The Institute of Chartered Accountants of England and Wales has defined management
accounting as any from of accounting which enables a business to be conducted more
efficiently.
Management Accounting Team of Anglo-American Council on Productivity has described the
term Management Accounting as the presentation of accounting information in such a way
so as to assist management in the creation of policy and the day to day operation of an
undertaking.
American Accounting Association has defined the term Management Accounting as the
application of appropriate techniques and concepts in processing historical and projected
economic data of an entity to assist management in establishing plans for reasonable economic
objectives and in the making of rational decisions with a view towards these objectives.
The various definitions of the term Management Accounting reveal the following features of
the same.
(1)
Management Accounting is a service function which is concerned with providing various

information to the management to facilitate decision making and review of implementation
of those decisions.
(2)
Management Accounting uses not only the historical data but may also use the data
based on projections and forecasts for the purpose of evaluation of various possible
alternatives.
(3)
Management Accounting assists the management in establishing the plans to attain the
economic objectives and in taking proper decisions required to be taken for the attainment
of these objectives.
(4)
Management Accounting involves the application of various special techniques and

concepts for the attainment of its objects. The techniques used in the process of
management accounting are discussed in the following chapters.
Objects of Management Accounting

The above discussions reveal that the Management Accountant is an invaluable aid to the
management to discharge the basic functions of planning, execution and control. This is done
by (1)
Making available accounting and other data to enable the management to plan effectively.
(2)
Measuring the actual performance and reporting the same to the various levels of
management to indicate the effectiveness of the organisational methods used.
(3)
Computation of deviation of actual performance from the plans and standards set.
(4)
Presenting to the management the operating and financial statements at reasonable

intervals and interpreting the same to enable the management to take action/decisions
regarding future policy and operations.
Scope of Management Accounting

After considering the various objectives the Management Accounting aims at, it can be noted
that the scope of Management Accounting is much wider. It covers virtually every area and
every aspect of business operations. However, to be more precise, the various areas covered
by Management Accounting can be stated as below.
(1)
Accounting : It deals with recording, summarising and analysing various business

transactions. The process of accounting may take basically two forms.
(a)
Introduction
Financial Accounting : It deals with recording the business transaction which are
financial in nature. It aims at the preparation of what is called financial statements
which may be basically in two forms. Firstly, the Balance Sheet which tells about
the state of affairs of the business in terms of the various assets and liabilities and
Secondly, the profitability statement which tells about the result of operations of
the business i.e. profit earned or loss incurred. The financial statements are mainly
meant for the outsiders dealing with the business.
(b)
(2)
Cost Accounting : It deals with recording of income and expenditure, ascertainment

of cost and profitability and the presentation of information derived therefrom for the
purpose of managerial decision making. Thus, the cost accounting is basically
meant for the management to enable it to take decisions.
Cost Control Procedures : It deals with the various steps involved in the process of
controlling the cost. Thus, in turn it may deal with.
(a)
Establishment of plans or budgets for the future.
(b)
Comparison of actual performance with the planned or budgeted performance.
(c)
Computation of variations between the planned and actual performance.
(3)
Reporting : It deals with the presentation of cost data, statistical data or any other
information to the various levels of management. It may be required for the purpose of
decision making or for the purpose of fulfillment of various legal obligations.
(4)
Taxation : It deals with the computation of income as per the law and filing the tax
returns and making the tax payments.
(5)
Audit : It deals with devising the internal control systems and internal audit system to
cover the various operational areas of business. In many cases, it may also deal with the
management audit which is the evaluation of the managerial performance.
(6)
Methods and Services : It deals with providing the management services and the
management information systems. It also deals with the various methods of reducing
the cost and improve efficiency of accounting and other office operations and preparing
and issuing the accounting and other operational manuals.
Disadvantages/Limitations of Management Accounting

In spite of the various advantages available from the management accounting in the era of ever
increasing complex business operations, it suffers from some limitations,
(1)
A very wide scope of management accounting is the limitation by itself. It attempts to

operate in a wide range of areas and it is quite possible that it may not be able to make
proper justification to all of them.
(2)
In spite of the fact that the management accounting provides the various details required
for qualitative decision making thus attempting to avoid the possibility of intuitive decision
making, in many cases in practice, the decisions are based upon the intuition of the
decision maker rather than the scientific data available therefor.
(3)
The installation and operation of management accounting requires a very elaborate

organisational structure and a large number of rules and regulations. It may make the
management accounting system a costly proposition which can be implemented only
by large scale organisations.
(4)
Management Accounting system is still in the evolution stage and hence suffers from
the various limitations which any system may face in the initial stages like the requirement
of constant improvements of the techniques and uncertainty about the application of the
system etc.
(5)
The installation and operation of management accounting system may call for the radical
changes in the entire organisational structure which may cause severe opposition and
resistance from the existing personnel.
FINANCIAL ACCOUNTING AND COST ACCOUNTING COMPARED

(a)
Financial Accounting is concerned about the calculation of the profitability and state of
affairs of the organization as a whole with the help of preparation of the financial
statements. Financial Accounting takes into consideration only the historical data which
may not be of any use from the cost control point of view.
Cost Accounting may deal with the ascertainment of cost and calculation of profitability
of the individual products, departments, branches and so on. Cost Accounting involves a
much-detailed study of costs and profitability which takes into consideration not only
historical data but also the future events and possibilities. As such, cost accounting
proves to be better proposition from the cost control point of view.
(b)
Due to the various statutory regulations, maintenance of financial accounting records

and preparation of financial statements therefrom is more or less a legal requirement.
Maintenance of cost accounting records is not a legal requirement except in case of
certain company form of organizations where maintenance of cost accounting records
has been made compulsory as per the provisions of Section 209 (1) (d) of the Companies
Act, 1956.
(c)
Financial Accounting primarily protects the interests of the outsiders dealing with the
organization in various capacities like investors, suppliers, customers, banks, financial
institutions, government authority etc.
Cost Accounting is primarily meant for the management to enable the same to discharge
various functions in a proper manner i.e. planning, execution, co-ordination and decisionmaking.
Introduction
This relationship between Cost Accounting and Financial Accounting can be better
explained with the help of the following illustration which states the presentation of the
profitability statement under both the sets accounting.
(a)
Profit and Loss Account for the year ended on 31st march 1990.
To, Material Cost
1,50,000
To, Labour Cost
1,00,000
To, Factory Expenses
By sales
5,00,000
50,000
To, Gross Profit c/fd

(40% of sales)
2,00,000
5,00,000
5,00,000
To, Administration
By Gross Profit
Expenses
90,000
To, Selling Expenses
50,000
To, Net Profit (12% of sales)
60,000
C/f
2,00,000
2,00,000
(b)
2,00,000
Cost Accounting
Products
Total
Material Cost
1,50,000
20,000
50,000
80,000
Labour Cost
1,00,000
15,000
30,000
55,000
PRIME Cost
2,50,000
35,000
80,000
1,35,000
50,000
20,000
10,000
20,000
3,00,000
55,000
90,000
1,55,000
Administration Expenses
90,000
40,000
20,000
30,000
Selling Expenses
50,000
15,000
20,000
15,000
4,40,000
1,10,000
1,30,000
2,00,000
60,000
(-) 10,000
20,000
50,000
5,00,000
1,00,000
1,50,000
2,50,000
12%
13.33%
20%
Factory Expenses
FACTORY Cost
TOTAL COST
Profit
SALES
Profit % on sales
10
Financial Accounting and Management Accounting compared

(a)
For the purpose of extracting the data required for managerial decision-making,
Management Accounting may use the information appearing in the financial statements.
This information may be used as it is or it can be rearranged or regrouped if required. As
such, financial accounting becomes a source of information for management accounting.
(b)
Financial Accounting considers only the historical financial transactions and does not
consider the non-financial transactions.
As Management Accounting aims at enabling the management to take the decisions
about the future, it may consider future data as well as non-financial factors.
(c)
As stated earlier, due to the various statutory regulations, maintenance of financial

accounting records and preparation of financial statements therefrom is more or less a
legal requirement. Moreover, the format in which the financial statements are required to
be prepared is also standardized.
Management Accounting is not at all a legal requirement. Management is free to install
or not to install a management accounting system. Further, these systems have their
own reporting formats.
(d)
As stated earlier, financial accounting primarily protects the interests of the outsiders
dealing with organization in various capacities like investors, suppliers, customers, banks,
financial institutions, government authorities etc.
The reports generated by management accounting are meant for the use by management
for effective decision-making.
(e)
As stated earlier, the financial statements which are generated as a result of financial
accounting, report the financial performance of the organization as a whole.
Reports generated by the management accounting may deal with the various parts of
the organization. As such, management accounting reports may deal with the individual
department or the individual product also.
(f)
The reports generated by financial accounting which are in the form of financial statements
are available only after the relevant accounting period is over. E.g. Balance Sheet as on
31st March 2002 is available after 31st March 2002. As such, financial accounting data
may not be available to the management for decision-making purposes. Moreover, as
the financial accounting data is available after a time lag, the financial statements are
required to be accurate.
Introduction
11
In case of management accounting, more emphasis is on making the data available to

the management as quickly as possible to facilitate the effective decision-making. If upto-date information is not made available to the management for decision-making,
management accounting will loose its utility. As such, accuracy is not the prerequisite
of management accounting.
Cost Accounting and Management Accounting compared
Cost Accounting and Management Accounting are similar to each other in many respects.
Both the streams of accounting primarily aim at the effective decision making on the part of
management. Both the streams of accounting are on and average not a legal requirement. The
various techniques which are used by management accounting viz. Marginal Costing, Budgetary
Control, Standard Costing, Uniform Costing etc. are basically regarded as the advanced
methods of Cost Accounting. As such Cost Accounting may be considered to be a part of
Management Accounting. Management Accounting is an extension of managerial aspects of
cost accounting with the ultimate intention to protect the interests of the business.
Techniques of Management Accounting
There may be various techniques with the help of which the basic functions of management
accounting can be discharged. We will discuss the following techniques in details in the
following chapters-
12
Marginal Costing (Break Even Analysis)
Budgetary Control
Standard Costing
Uniform Costing
QUESTIONS
1.
Explain the nature and characteristic features of Financial Accounting and Cost
Accounting. How are they related to each other?
2.
What do you mean by Management Accounting?

State the advantages and limitations of Management Accounting. How Management
Accounting is related with other streams of accounting?
Introduction
13
NOTES
14
Chapter 2
BASICS OF FINANCIAL ACCOUNTING
As stated earlier, financial accounting is the process of recording the past financial business
transactions and calculating the net result of these transactions, with the intention to
communicate the same to the various persons dealing with the business in the external
capacity. However, financial accounting is the technical process. Before we consider the
technicalities of financial accounting, let us consider some of the fundamental issues relating
to the financial accounting.
ACCOUNTING PRINCIPLES
In order to bring the uniformity in recording the business transactions, the accountants follow
certain basic procedures universally. These are referred to as the Accounting Principles. The
Accounting Principles can be classified in two categories
a.
Accounting Concepts
b.
Accounting Conventions
Accounting Concepts
Accounting Concepts indicate those basic assumptions upon which the basic process of
accounting is based. Following are the important Accounting Concepts :
Business Entity Concept
This accounting concept proposes that the business is assumed to be a distinct entity than
the person who owns the business. The accounting process is carried out for the business
and not for the person who owns the business. E.g. If there is a partnership concern carrying
on the business in the name of M/s. XYZ & Co., where Mr. A and Mr. B are the equal partners,
M/s. XYZ & Co. is supposed to be a separate entity from Mr. A and Mr. B. The financial
statements prepared on the basis of accounting records are of M/s. XYZ & Co. and not of Mr.
A or Mr. B individually. It should be noted in this connection that the business entity concept
has nothing to do with the legal entity of the business. It applies to both corporate organization
15
(which by itself is a separate legal entity from the owners) as well as non-corporate organization
(which is not a legal entity separate from the owners).
Dual Aspect Concept
This concept proposes that every business transaction has two aspects. However, basic
relationship between assets and liabilities i.e. assets are equal to liabilities, remains the
same. E.g. If Mr. A starts the business by introducing the capital of Rs. 50,000, the assets
and liabilities structure will be as below Liabilities
Capital
50,000
Assets
Cash
50,000
Now, if Mr. A uses the cash to purchase the material worth Rs. 40,000, the assets and
liabilities structure will change as below
Liabilities
Capital
50,000
Assets
Cash
Stock in Trade
50,000
10,000
40,000
50,000
If Mr. A sells the above material worth Rs. 40,000 for Rs. 45,000 on credit basis, the assets
and liabilities structure will change as below
Liabilities
Capital
55,000
55,000
Assets
Cash
Receivables
10,000
45,000
55,000
Going Concern Concept

This concept proposes that the business organization is going to be in existence for an
indefinitely longer period of time and is not likely to close down the business in the shorter
period of time. This affects the valuation of assets and liabilities. As such, the assets are
disclosed in the Balance Sheet at cost less depreciation and not at the current market price.
If the assets are to be disclosed in the Balance Sheet at correct value, the current market
price will be most suitable. However, as the business is likely to exist for an indefinitely longer
period of time and as the assets are not likely to be sold off in the market in the near future, the
market price becomes immaterial.
Accounting Period Concept
Even if the Going Concern Concept proposes that the business is going to be in existence for
an indefinitely longer period of time, in order to facilitate the preparation of financial statements
on periodical basis, the indefinitely longer life span on the business is divided into shorter time
16
segments, each one being in the form of Accounting Period. Profitability is computed for this
accounting period (by preparing the profitability statement) and the finanial position is assesseed
at the end of this accounting period (by preparing the balance sheet). It should be noted that
the selection of accounting period may depend upon the various factors like characteristics of
the business organization, tax considerations, statutory requirements etc.
Cost Concept
This concept proposes that the assets acquired by the organization are recorded at their cost
of acquisition and this cost is considered for all the subsequent accounting purposes say
charging of depreciation. This concept does not take into consideration current market prices
of the various assets.
Money Measurement Concept
This concept proposes that only those transactions and facts find the place in accounting
which can be expressed in terms of money. As such, all those transactions and facts which
can not be expressed in terms of money (E.g. Morale and motivation of the workers, credibility
of the business organization in the market etc.) do not find any place in accounting and that is
why in financial statements, though they may be having direct or indirect bearing on the
business. This concept imposes severe restrictions on the kind of information available from
the financial statements. In fact, this is one of the major drawbacks of financial accounting
and financial statements.
Matching Concept
This concept proposes that while calculating profit for the accounting period in a correct
manner, the expenses and costs incurred during the period, whether paid or not, should be
matched with the revenues generated during the period. E.g. If the accounting period ends on
31st March, the salaries for the month of March should be considered as cost for the year
ending on 31st March, even if they are actually paid for in the month of April. Otherwise,
calculation of the profits for the year ending on 31st March will go wrong as the income will be
for 12 months while the expenses will be for 11 months only.
Accounting Conventions
Accounting Conventions indicate those customs and traditions that are followed by the
accountants while preparing the financial statements. Following are the important Accounting
Conventions.
Convention of Conservation
This convention is usually expressed as anticipate all the future losses and expenses, however
do not consider the future incomes and profits unless they are actually realized. This convention
generally applies to the valuation of current assets and as such, the current assets are valued
17
at cost or market price whichever is lower. The valuation of non-curret assets is done at cost
(as per the cost concept).
Convention of Materiality
This convention proposes that, while accounting for the various transactions, only those
transactions will be considered which have material impact on profitability or financial status
of the organization and other insignificant transactions will be ignored. E.g. If the organization
purchases some postal stamps, some of which remain unused at the end of the accounting
period. According to matching concept, the cost of such non-used postal stamps should not
be considered as the item of cost. However as its impact on the overall profitability is likely to
be negligible, the cost of non-used postal stamps may be ignored treating the cost of purchases
as the expenditure. Which transactions should be treated as material ones is a subjective
concept and depends upon the judgment and knowledge of the accountant.
Convention of Consistency
This convention proposes that the accounting polices and procedures should be followed
consistently on period-to-period basis so as to facilitiate the comparison of finanacial statements
on period-to-period basis. If there is any change in the accounting policies and procedures,
this fact coupled with its effect on profitabity should be disclosed explicitly while preparing the
financial statements.
SYSTEMS OF ACCOUNTING
a.
Cash System of Accounting

In this system of accounting, expenses are considered to be the expenses only when
they are paid for and the incomes are considered to be incomes only when they are
actually received. This system of accounting is mainly used by the organizations
established not for earning the profits. This system of accounting is considered to be
defective in nature, as it may not represent the true picture of the profitability as well as
of the state of affairs.
b.
Mercantile or Accrual System of Accounting

In this system of accounting, expenses are considered as expenses during the period to
which they pertain. Similarly, incomes are considered to be incomes during the period to
which they pertain. When the expenses are actually paid for or when the incomes are
actually received is not significant in case of Mercantile or Accrual system of accounting.
This system of accounting is considered to be more ideal, generally preferred by the
accountants. However, as the time of physical receipt of cash is immaterial in this system
of accounting, Accrual System of Accounting may result into the unrealized profits being
18
reflected in the books of accounts on which the organization may be required to pay
the taxes also.
It will not be out of place to mention here that, as per the provisions of Section 209
of the Companies Act, 1956, all the company form of organizations are legally required
to follow Mercantile or Accrual system of accounting. Other organizations have a
choice to select either of the systems of accounting.
TYPES OF EXPENDITURE
For the purpose of accounting, the amount of money that is paid for is classified in three
ways
a.
Capital Expenditure
Capital Expenditure indicates the amount of funds paid for acquiring the infrastructural
properties required for doing the business that are technically referred to as Fixed
Assets. Fixed Assets do not give the returns during the same period during which
they are paid for. As such, benefits available from capital expenditure are long-term
benefits. Hence, it will be wrong to consider the capital expenditure as expenses
while calculating the profitability during a certain period. In technical words, capital
expenditure never affects the Profitability Statement, except in case of Depreciation,
which in simple words indicates that part of capital expenditure returns equivalent to
which are received during the corresponding period.
b.
Revenue Expenditure
Revenue Expenditure indicates the amount of funds paid during a certain period with
the intention to receive the return during the same period. As such, the benefits
available from revenue expenditure are received during the same period during which
they are paid for. The entire amount of revenue expenditure affects the Profitability
Statement.
c.
Deferred Revenue Expenditure

Deferred Revenue Expenditure indicates the amount of funds paid which does not
result into the acquisition of any fixed asset. However, at the same time benefits
from this expenditure are not received during the same period during which they are
paid for. The examples of Deferred Revenue Expenditure are
a.
Initial Advertisement Expenditure
b.
Research and Development Expenditure
c.
In case of company form of organization, Preliminary Expenses or Company

Formation Expenses.
19
Principally, Deferred Revenue Expenditure is not transferred to Profitability Statement

during the period during which they are paid for. As such, deferred revenue expenditure
does not affect the profitability of the period during which it is paid for. It is transferred to
Profitability Statement (in technical words written off to Profitability Statement) over the
period over which benefits are received, by passing the adjustment entry. As such,
deferred revenue expenditure affects the profitability only when they are written off to
Profitability Statement. Till they are written off to Profitability Statement, they are shown
on the Asset side of Balance Sheet.
GLOSSARY OF TERMS USED IN FINANCIAL ACCOUNTING
1.
Account Account is the record of all the transactions pertaining to a person, asset,
liability, income or expenditure which have taken place during a specified period and
shows the net effect of all these transactions finally.
2.
Debit Side Debit Side of the account is left hand side of the account.
3.
Credit Side Credit Side of the account is right hand side of the account.
4.
Voucher Voucher is any documentary evidence to justify that a particular transaction

has taken place. The voucher can be internal voucher or external voucher.
5.
Entry Entry means the record of a financial transaction in the books of accounts.
6.
To debit To debit an account means to make the entry on debit side of the account.
7.
To credit To credit an account means to make the entry on credit side of the account.
8.
Journal Journal is the Book of Original Entry or the Book of Prime Entry where the
financial transactions are recorded in the chronological order as and when they take
place.
9.
Ledger Ledger is the book where the transactions of the similar nature are pooled
together under one Ledger Account. Ledger or General Ledger as it is referred to in
practical circumstances, maintains all types of accounts i.e. Personal, Real and Nominal.
Whichever transactions are recorded in the Journal or Subsidiary Books in chronological
order, the same transactions are posted in the Ledger, account wise.
10. Narration Narration is the summarized explanation or description of the financial

transaction recorded in the books of accounts.
11.
Casting Casting refers to totalling of the books of accounts.
12. Posting Posting refers to the process of transferring the transaction entered into the
book or original entry or subsidiary book to the ledger account.
20
13. Folio Folio refers to the page number of the book of original entry or the ledger.
14. Brought Forward When the balances in the ledger account or cash/bank book of the
previous year or previous period are entered in the current years books of accounts, the
balances are said to be Brought Forward.
15. Carried Forward When the balances in the ledger account or cash/bank book of the
current year or current period are to be transferred to the next years books of accounts,
the balances are said to be Carried Forward.
16. Assets All the properties owned by the business are collectively referred to as the
assets of the business.
17. Liabilities All the amounts owed by the business to various providers of funds or services
are collectively referred to as liabilities.
18. Capital Capital indicates the amount of funds invested by the owner of the business in
the business.
19. Drawings Drawings indicates the amount of funds or goods withdrawn by the owner of
the business for the personal use.
20. Debtor A Debtor is a customer who owes the money to the business for the goods or
services supplied to him on credit basis.
21. Creditor A Creditor is a supplier to whom the business owes the money for the goods
or services bought from him on credit basis.
22. Debit Note Debit Note is an intimation sent to a person dealing with the business that
his account is being debited for the purpose indicated therein.
23. Credit Note Credit Note is an intimation sent to a person dealing with the business that
his account is being credited for the purpose indicated therein.
24. Trade Discount Trade Discount is the discount received on purchases or discount
allowed on sales which is an adjustment with the basic purchase or sales price. Trade
discount is not accounted for in the books of accounts. Purchase value or sales value is
accounted for net of trade discount.
25. Cash Discount Cash discount is the discount received from the suppliers or allowed to
customers for making the early payment of dues. Cash discount is accounted for in the
books of accounts. Cash discount received from the suppliers is revenue income and
cash discount allowed to the customers is revenue expenditure.
21
26. Balance Sheet Balance Sheet is the summarized statement of what the business
owns i.e. assets and what the business owes i.e. liabilities at any given point of time.
27. Bills Payable Bills Payable indicates the amount payable to the suppliers for which the
negotiable instrument in the form of Bill of Exchange is given to the suppliers.
28. Bills Receivable Bills Receivable indicates the amount receivable from the customers
for which the negotiable instrument in the form of Bill of Exchange is received from the
customer.
29. Depreciation The term Depreciation applies to fixed assets like Land, Buildings,
Machinery, Furniture, Vehicles etc. The term indicates reduction in the value of fixed
assets which can arise either due to time factor or use factor or both. A detailed note on
Depreciation Accounting is enclosed in the Annexure.
DOUBLE ENTRY SYSTEM OF ACCOUNTING
The basic presumption made by the Double Entry System of Accounting is that every business
transaction has two elements i.e. when the business receives something, it has to pay
something. Eg. If the business pays the telephone bill in cash, it gets the benefit of using the
telephone, but at the same time cash goes out. Similarly, if goods are sold to the customer for
cash, goods of the business go out, but it receives the corresponding amount of cash.
Accordingly, if Double Entry System of Accounting is followed, every business transaction
affects two accounts. One account is debited, while another account is credited by the similar
amount. Thus, Double Entry System of Accounting follows the principle of every debit has a
corresponding credit and hence, total of all debits has to be equal to the total of all credits.
Double Entry System of Accounting proves to be advantageous due to certain reasons
a.
It takes into consideration both the aspects of each business transaction.
b.
Arithmetical accuracy of the accounting records can be verified by preparing

the Trial Balance.
c.
The correct result of operations can be ascertained by preparing the final accounts
periodically.
d.
Correct valuation of assets and liabilities is possible at any given point of time by preparing
the Balance Sheet.
TYPES OF ACCOUNTS
The various accounts for the purpose of Financial Accounting get classified under the following
categories
22
1.
2.
Personal Accounts - These are the accounts of persons with whom the organization
deals in various capacities. In practical circumstances, personal accounts may consist
of the following types of accounts
Accounts of the suppliers
Accounts of the customers
Bank / Financial Institutions
Capital Account
Real Accounts These are the accounts of assets and liabilities. In practical
circumstances, real accounts may consist of the following types of accounts
Land Account
Building Account
Machinery Account
Furniture Account
Vehicles Account
Real Accounts may also consist of the accounts of some intangible assets like
3.
Goodwill Account
Patents and Trade Marks Account
Nominal Accounts These are the accounts of incomes or expenses. In practical

circumstances, nominal accounts may consist of following types of accounts
Salary Account
Wages Account
Printing & Stationary Account
Insurance Account
Telephone Expenses Account
Interest paid or Received Account
Commission paid or Received Account
RULES OF DOUBLE ENTRY BOOK KEEPING

While entering into various financial transactions in the records maintained by the organization,
following basic rules for accounting are followed
a.
In case of Personal Accounts Debit the Receiver, Credit the Giver
b.
In case of Real Accounts Debit What Comes in, Credit What Goes out
c.
In case of Nominal Accounts Debit all the expenses, Credit all the incomes
23
ANNEXURE
Depreciation Accounting
Depreciation can be defined as a permanent, continuous and gradual reduction in the book
value of a fixed asset. Normally, all the fixed assets except land, depreciate in value rendering
the asset useless after the end of certain specific period. Following may be stated as the main
causes of depreciation.
(1)
Use factor : The fixed assets depreciate because they are used for the purpose they are
meant for. It is applicable in case of tangible assets like machinery, furniture, office
equipments etc.
(2)
Time factor : The fixed assets depreciate due to the passage of time.
(3)
Obsolescence : It is the reduction in the value of fixed assets, say a machine, due to its
supersession at a date before it is completely worn out. It may take place due to new
inventions, modifications or improvements.
Need for Depreciation Accounting :

According to the nature of fixed assets, these are those assets which may be used for the
business purposes over a certain number of future accounting periods and the benefit received
from them is spread over the said number of future accounting periods. According to the
matching principle of accounting, the costs incurred during an accounting period are required
to be matched with the benefits or revenues earned daring that period. Hence, it is necessary
to distribute the cost of a fixed asset, less the scrap or salvage or realisable value, after the
useful life of the fixed asset is over, in such a way so as to allocate it as equitably as possible
to the periods during which the benefits are received from the use of fixed assets. This system
or procedure is called depreciation accounting. Thus the depreciation accounting is necessary
for two main purposes.
(a)
To ascertain due profits by correctly matching the various costs and expenses incurred
with various incomes and revenues earned during various accounting periods.
(b)
To represent the value of a fixed asset on the Balance Sheet at its unexpired cost i.e. at
book value less depreciation. If depreciation is not provided, the asset may appear in the
Balance Sheet at an overstated amount.
It may also be noted in this connection that the depreciation forms a part of cost for arriving at
the profits which can be distributed to the owners of the business in the form of dividend. By
providing the depreciation, the amount of distributable profits is reduced and retained in the
business, which can be utilized for the replacement of the asset at the end of its economic
life.
24
Methods for Calculating Depreciation :

There may be various methods available for calculating the amount of depreciation to be
charged to Profit and Loss Account. Amount of depreciation is a function of various factors.
(1) Time, (2) Usage, (3) Time and Usage, (4) Time and Cost of maintaining the fixed asset,
(5) Provision of funds for replacing the assets.
As such the various methods available for charging the depreciation can be described as
below.
(1)
Straight Line Method :
According to this method, the amount of yearly depreciation is calculated as below.

Cost of asset - Estimated scrap value
Estimated life in years
Eg.
C = Cost of Asset.
Rs. 1,10,000
Estimated scrap value

(At the end of life of the asset)
Rs. 10,000
Estimated life
10 years
Rs. 1,10,000 - Rs. 10,000
Yearly depreciation
10 years
Rs. 10,000
The benefit of this method is that equal amount of depreciation is charged every year throughout
the life of the asset, making the calculation of depreciation and cost comparison easy. The
main drawback of this method is that the amount of depreciation in later years is high when
the utility of the asset is reduced.
(2)
Written Down Value (Reducing Balance) Method :
According to this method, the depreciation is provided at a predetermined percentage, on the

balance of cost of asset after deducting the depreciation previously charged (usually termed
as written down value).
Eg. Cost of asset
Rs.
1,10,000
Rs.
10,000
Cost of asset subjected to depreciation
Rs.
1,00,000
Rate of depreciation
10%
25
The amount of depreciation is calculated as shown below.

Year
Balance Cost
of Assets
Rs.
Depreciation
Rs.
Written Down
Value - WDV
Rs.
1,00,000
10,000
90,000
90,000
9,000
81,000
81,000
8,100
72,900
72,900
7,290
65,610
65,610
6,561
59,049
The rate of depreciation to be charged is calculated according to the following formula.
where
D =
1-
number of years
R =
Residual / Scrap Value
C =
Cost of the asset
The main benefit of this method is that it recognizes the fact that in the initial years of life of the
asset, the repairs and maintenance cost is less which goes on increasing gradually with the
progressing life of asset. According to this method, the higher amount of depreciation in the
initial years and a gradual decrease therein is counterbalanced by the lower amount of repairs
and maintenance cost in the initial years and a gradual increase therein. It should be noted
here that the written down value can never become zero.
(3)
Production Unit Method :
According to this method, depreciation is provided at a predetermined rate per unit which in
turn is calculated on the basis of total number of units lo be produced during the life of the
asset.
Eg. Cost of the machine
Rs. 1,10,000
Rs. 10,000
Estimated number of units to be produced
50,000
Rs. 1,10,000 - Rs. 10,000
Rate of depreciation per unit
=
=
26
50,000 units
Rs. 2
If in a particular year, 7,000 units are produced, the depreciation to be charged will be :
7,000 units x Rs. 2 per unit = Rs. 14,000.
This method gives more stress on usage factor rather than time factor. Higher the number of
units produced, higher is the amount of depreciation and vice versa.
(4)
Production Hour Method :
This method is similar to the production unit method except that instead of number of units to
be produced during the life of asset, number of hours for which the asset is expected to work
are taken into consideration.
Rs. 1,10,000
Rs.10,000
Estimated number of hours
25,000
Rate of depreciation per hour
Rs. 1,10,000 - Rs. 10,000

25,000 hours
Rs. 4
If in a particular year, the machine works for 2,500 hours, the depreciation to be charged will
be :
2,500 hours x Rs. 4 per hour = Rs. 10,000
(5)
Joint Factor Rate Method :
According to this method, the depreciation is provided partly at a fixed rate on time basis and
partly at a variable rate on usage basis.
Rs. 1,00,000
To be depreciated on time basis over life of the machine

i.e. 10 year
Rs.
Estimated number of units to be produced
50,000
50,000
Depreciation :
(a)
On time basis
Rs. 50,000
10 years
(b)
On usage basis
Rs. 50,000
Rs. 5,000 per year
Re. 1 per unit
50,000 units
27
If in a particular year, the machine produces 6,000 units, the depreciation to be charged
will be :
Time basis
Rs. 5,000
Usage basis 6,000 units x Re. 1
Rs. 6,000
Rs. 11,000
(6)
Annuity Method :
This method assumes that the amount of capital invested in the fixed assets would have
earned interest had it been invested otherwise. The depreciation to be charged under this
method is a constant proportion of the aggregate of the cost of the asset depreciated and
interest at the specific rate on written down value of the asset at the beginning of each period.
Eg.
Cost of the asset (c)
Rs. 1,00,000
Life of the asset (n)
5 years
Rate of interest (r)
10%
Depreciation to be charged is calculated as below.

D
=
1-
Year
Cxr
1,00,000 x 0.10
=
1
(1 + r)n -1
1-
Rs. 26,380
1
(1.10)5 -1
Cost/WDV
Interest
Total
Depreciation
WDV C/fd
Rs.
Rs.
Rs.
Rs.
1,00,000
10,000
1,10,000
26,380
83,620
83,620
8,362
91,982
26,380
65,602
65,602
6,560
72,162
26,380
45,782
45,782
4,578
50,360
26,380
23,980
23,980
2,400
26,380
26,380
Nil
The amount of depreciation is very high under this method and covers the opportunity cost of
non-investment of the capital anywhere else.
(7)
Sinking Fund Method :
Unlike any other method, this method attempts to make available funds equivalent to the
original cost of asset, at the end of useful life of the asset. According to this method, depreciation
to be charged is the fixed period charge which is invested at a compound rate and the amount
of investmen with the compounded interest earned over the life of the asset equals to the
original cost of the asset.
28
Eg.
Cost of the asset (c)
Rs. 1,00,000
Life of the asset (n)
5 years
Rate of interest (r)
10%
Depreciation to be charged is calculated as below :

D
Year
(8)
Cxr
1,00,000 x 0.10
(1.10)5 - 1
(1 + r) - 1
Bal. B/fd
Rs. 26,380
Annual
Investment
Rs.
Annual
Bal.c/fd
Rs.
Interest
Provision
Rs.
Rs.
Rs.
16,380
16,380
16,380
16,380
1,638
16,380
18,018
34,398
34,398
3,440
16,380
19,820
54,218
54,218
5,422
16,380
21,802
76,020
76,020
7,600
16,380
23,980
1,00,000
Endowment Policy Method :
This method is similar to sinking fund method. Under this method, an insurance policy is
taken out for the amount required to replace the asset at the end of life of the asset. The
amount of depreciation to be charged is equal to the annual premium payable on the insurance
policy, which is decided by the insurance company.
(9)
Revaluation Method :
According to this method, the asset is revalued periodically. The amount of depreciation for
that period is the difference between the cost of the asset at the beginning of the period and
the amount of revaluation at the end of the period.
This method of charging the depreciation is extensively used for the assets like livestock,
patterns etc.
(10) Renewal Method :
According to this method, the full cost of the asset is charged as depreciation during the
period in which asset is renewed. No depreciation is charged in between the period. This
method of charging can be used if the asset is of small value and is renewed frequently.
29
Practical considerations relating to depreciation
30
1.
In spite of the fact that there are various methods available for calculating the depreciation,
the final choice of the method depends upon the individual organization. It should be
noted that Income Tax Act, 1961 which is a very important piece of legislation applicable
to all types of business organizations, recognizes only one method for calculating the
depreciation i.e. Written Down Value method. The rates at which the depreciation is to
be calculated are also specified in the Income Tax Act, 1961. If the organization wants to
calculate the depreciation on some different basis or at some different rates, it can do so
for financial accounting purposes. However, for calculating the tax liability, the depreciation
has to be calculated on Written Down Value basis and that too at the specified rates.
2.
The company form of organizations to whom the provision of Companies Act, 1956 apply
are required to calculate the depreciation as per the provisions of Schedule XIV of the
Companies Act, 1956. The salient features of Schedule XIV of the Companies Act, 1956
can be stated as below a.
Schedule XIV of the Companies Act, 1956 provides that the company can calculate
the depreciation by using either Written Down Value method or Straight Line method.
The companies are given the choice to select between these two methods. The
actual choice of the method may depend upon the effect on the profitability of the
company. If the company wants to change the method of calculating the depreciation,
it amounts to the change in accounting policy. Any change in the method of
calculating the depreciation has to be effected with retrospective effect from the
date of incorporation of the company. The company is required to disclose the fact
of change in the method of calculating the depreciation while preparing its financial
statements along with the effect of change in the method of calculating the
depreciation.
b.
The rates at which the companies are required to calculate the depreciation are
also specified in Schedule XIV. For this purpose, the fixed assets are classified in
various categories. The broad categorization of the fixed assets is as below l
Buildings - Factory Building as well as Administration Buildings
Plant and Machinery
Furniture
Vehicles
Computer Installations
The rates for calculation of depreciation are as below Nature of the Fixed Assets
WDV
SLM
Buildings - Factory
10%
3.63%
5%
1.63%
Plant and Machinery
15%
4.75%
Furniture
10%
6.33%
Vehicles
20%
9.5%
Computer Installations
40%
16.21%
Buildings - Administrative
c.
If during the financial year, any addition has been made to any asset or any asset
has been sold, the depreciation on such asset will be calculated on a pro rata basis
from the date of such addition or upto the date on which such asset has been sold.
There are some of the questions which are normally raised in respect of the nature
of depreciation.
(1)
Is Depreciation a cost?
Yes, depreciation is a cost because of the obvious reasons that it reduces the
profitability and it is a charge against the profit. At the same time, it should
also be noted that it is a non-cash cost as it is never paid or incurred in cash.
(2)
Does Depreciation generate funds for replacement of assets?

If the depreciation is provided under the Sinking Fund Method or Endowment
Policy Method, sufficient funds may be available, at the end of life of the
asset, equivalent to the original cost of the asset. As such, it can be said that
these two methods make available the funds equivalent to the original cost of
the asset at the end of life of the asset. However these funds may not be
sufficient to replace the asset due to the increased price of the same. Other
methods of charging the depreciation do not directly generate the funds required
for replacing the assets. The fact that the assets are depreciated to the extent
of almost entire of the original cost of the same, does not indicate that the
funds are available for the replacement purpose. However, depreciation may
be viewed from one more angle. It is a charge to profits which reduces the
profits which can be distributed among the shareholders by way of dividends,
thus conserving the business funds in the business itself. This may be
considered to be a very very indirect way of interpretation that the depreciation
involves a source of funds.
31
QUESTIONS
32
1.
What do you mean by various accounting principles? Explain the various accounting
concepts and conventions used in the financial accounting.
2.
Distinguish between the following pairs of terms.
Cash Basis of Accounting and Accrual Basis of Accounting
Revenue Expenditure and Capital Expenditure
Written Down Value Method and Straight Line Method of Depreciation
Depreciation as per Companies Act and Income Tax Act
3.
What do you mean by depreciation? What are the objectives for calculating the
depreciation? Explain the various methods for calculating the depreciation.
4.
Write an essay on Depreciation.
NOTES
33
NOTES
34
Chapter 3
PROCESS OF ACCOUNTING
JOURNALIZING
Journalizing refers to the process of recording the business transaction in the Journal that is
referred to as the Book of Original Entry or the Book of Prime Entry. The various transactions
are entered in the journal in the chronological order, as and when the transactions take place.
The Journal may look as stated below
Journal
Date
Particulars
L.F.
Debit Rs.
Credit Rs.
Account (To be Debited) Dr.

To, Account (To be Credited)
Narration
The Journal may be subdivided in the following five columns
a.
Date It refers to the date on which a particular transaction has taken place.
b.
Particulars It refers to titles of the account to be debited or credited. Title of the

account to be debited starts from the extreme left and the abbreviation Dr. is written to
the extreme right of the same column on the same line. Title of the account to be
credited is entered on the next line preceded by the words To leaving some space from
the extreme left. In the same column on the next line, brief description of the transaction
is written which is referred to as Narration. The narration conventionally starts with the
wording Being.
c.
L.F. This is the abbreviation of Ledger Folio. This column refers to the page number of
the ledger. The nature of Ledger is discussed in the following paragraphs.
d.
Amount Debited The amount to be debited is stated in this column.
e.
Amount Credited The amount to be credited is stated in this column.
35
Illustration
Journalize the following transactions in the books of Mr. Amit Sen
a.
b.
Mr. Sen commenced business with cash Rs. 10,000, Machinery Rs. 10,000, Buildings
Rs. 30,000 and Furniture Rs. 15,000.
Installed and paid for Neon Sign Board at a cost of Rs. 1,000
c.
Mr. Sen borrowed Rs. 25,000 from his wife and the same were deposited by him in bank
to open an account.
d.
Mr. Sen purchased goods for Rs. 7,000 for cash.
e.
Mr. Sen purchased goods worth Rs. 10,000 from Mr. Rao on credit @2% Cash Discount.
f.
Sold goods to Ramdas worth Rs. 15,000 against cash after allowing 5% Trade Discount.
g.
Paid Rs. 1,995 to Mr. Rajesh for purchases of goods after allowing 5% Cash Discount on
the invoice.
h.
Sent a cheque of Rs. 1,000 to Chief Ministers Fund as Mr. Sens personal contribution.
i.
Placed an order for goods worth Rs. 2,000 with M/s Archana Traders.
j.
A personal table fan worth Rs. 450 brought in the office for office use.
Solution
In the Books of Mr. Amit Sen
Date
Particulars
Cash A/c
Machinery A/c
Building A/c
Furniture A/c
To, Capital A/c
L.F.
Debit Rs.
Credit Rs.
10,000
10,000
30,000
15,000
65,000
(Business started with cash,

machinery, building and furniture)
Advertisement A/c
To, Cash A/c
(Being paid for neon sign board
installed)
36
1,000
1,000
Date
Particulars
Bank A/c
To, Loan from Mrs. Sen A/c
(Being the amount borrowed from
Mrs. Sen to open account with the
bank)
Purchases A/c
To, Cash A/c
L.F.
Debit Rs.
Credit Rs.
25,000
25,000
7,000
7,000
(Being paid for cash purchases)

Purchases A/c
To, Cash A/c
To, Discount Received
10,000
9,800
200
(Being purchases worth Rs. 10,000

after getting 2% cash discount)
Cash A/c
To, Sales
(Sold goods worth Rs. 15,000 after
allowing trade discount of 5%)
Purchases A/c
To, Cash A/c
To, Discount Received
14,250
14,250
2,100
1,995
105
(Paid Rs. 1,995 for goods purchased

after getting 5% cash discount)
Drawings A/c
To, Bank A/c
1,000
1,000
(Being donation paid to Chief Ministers

Fund as Mr. Sens personal contribution)
No Journal Entry will be passed, as the
transaction is not a financial transaction.
Furniture A/c
To, Capital A/c
450
450
(Being the personal table fan brought

for office use)
37
Compound Journal Entry

If the similar transactions take place on the same day and the same account is either debited
or credited, instead of passing different journal entries, it can be accounted for by passing a
compound journal entry. It avoids duplication and makes the journal less bulky.
Illustration
Mr. A commenced the business with cash Rs. 10,000, Machinery worth Rs. 25,000 and the
Computer worth Rs. 50,000. The transaction will be journalized as below
Date
1.4.2002
Particulars
L.F.
Debit Rs.
Cash A/c
Machinery A/c
Computer A/c
To, Capital A/c
(Commenced business with cash,
machinery and computer)
Credit Rs.
10,000
25,000
50,000
85,000
SUBSIDIARY BOOKS
If the volume of transactions is very large, recording all the transactions in the Journal may
prove to be a voluminous job. Hence, the transactions of the similar nature may be entered
into a separate Subsidiary Book and the net effect of the similar transactions may be transferred
into the main records.
In the practical circumstances, following subsidiary books are used very frequently
a.
Cash Book This records all the cash transactions i.e., Cash Receipts and Cash
Payments. In some cases, Cash and Bank Book may be maintained which records
Cash as well Bank Receipts and Cash as well as Bank Payments.
The Cash and Bank Book may look as below
Date
b.
Particulars
L.F.
Cash
Bank
Date
Particulars
L.F.
Cash
Bank
Purchases Register or Purchases Day Book This records all the credit purchases
transactions.
Date
Name of the Supplier
L.F.
Invoice No.
Amount
Note : L.F. stands for Ledger Folio Number which indicates the Page Number in the
Creditors Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs.
38
c.
Sales Register or Sales Day Book This records all the credit sales transactions.
The Sales Register may look as stated below
Date
Name of the Customer
L.F.
Invoice No.
Amount
Debtors Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs.
d.
Purchases Returns Register This records the transactions of return of goods to the
suppliers from whom purchases were made on credit basis.
The Purchases Return Register may look as stated below
Date
Name of the Supplier
L.F.
Debit Note No.
Amount
Creditors Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs. The Debit Note stands for an intimation sent to the supplier at the
time of returning the goods which informs the supplier that his account is being debited
on account of goods returned to him.
e.
Sales Returns Register This records all the transactions of return of goods by the
customers to whom sales were made on credit basis.
The Sales Return Register may look as stated below
Date
Name of the Customer
L.F.
Credit Note No.
Amount
Debtors Ledger as the Control Ledger. The term Control Ledger is discussed in the
following paragraphs. The Credit Note stands for an intimation sent to the customer at
the time of accepting the returned goods which informs the customer that his account is
being credited on account of goods returned by him.
f.
Journal Proper This records all the residual transaction which cannot be entered into
any other subsidiary book.
The transactions which can be entered in the Journal proper are
a.
Opening Entries
b.
Closing Entries
c.
Rectification Entries
d.
Adjustment Entries
39
LEDGER POSTING
If Journal or Subsidiary Books are the books which record of the transactions in the chronological
order, Ledger is the book where the transactions of the similar nature are pooled together
under one Ledger Account. Ledger or General Ledger as it is referred to in practical
circumstances, maintains all types of accounts i.e. Personal, Real and Nominal. Whichever
transactions are recorded in the Journal or Subsidiary Books in chronological order, the same
transactions are posted in the Ledger, account wise. Thus, a ledger account can be defined
as the record of all the transactions pertaining to a person, asset, liability, income or expenditure
which have taken place during a specified period and shows the net effect of all these
transactions finally. As such, the transactions are first entered into Journal or Subsidiary
Book when they take place and from there they are transferred to Ledger and this process is
called as Ledger Posting.
The Ledger Account may be maintained in two ways
Type I
Dr.
Cr.
Date
Particulars
Folio
Rs.
Date
Particulars
Folio
Rs.
Type II
Date
Particulars
Folio
Debit
Credit
Rs.
Balance
Rs.
Control Ledgers
In practical circumstances, if the transactions of purchases and sales are very large, it may
not be feasible to carry the accounts of all the suppliers and customers in the Main or General
Ledger. In such cases, apart from the Main Ledger or General Ledger, the Control Ledgers can
be maintained. Control Ledgers carry the individual accounts whereas the Main Ledger or
General Ledger records the consolidated effect of the individual transactions. As such, the
balance shown by the consolidated account in the Main Ledger or General Ledger has to tally
with the balances in the individual ledger accounts maintained in the control ledger. In practical
circumstances, control ledgers may be maintained for the following purposes
40
a.
Sundry Debtors
b.
Sundry Creditors
c.
Advances to Staff
Balancing of Ledger Accounts

To ascertain the net effect of all the transactions recorded in the Ledger Account, the account
is required to be balanced. Balancing of Ledger Account involves the following steps
a.
Take the total of both sides of the Ledger Account.
b.
Calculate the difference between totals of both the sides.
c.
If the total of debit side is heavier, place the difference on the amount column of credit
side by writing By Balance c/fd. If the total of credit side is heavier, place the difference
on the amount column of debit side by writing the To Balance c/fd. If the balance
appears on the credit side, the account will be considered to have Debit Balance. If the
balance appears on the debit side, the account will be considered to have Credit Balance.
d.
After balance is placed on the appropriate side, ensure that totals of both the sides
match with each other.
Illustration
Machinery Account
Date
Particulars
01.04.01 Balance b/fd

10.04.01 Bank
Folio
Rs.
Date
25,000 31.03.02
70,000 31.03.02
95,000
Particulars
Depreciation
Balance c/fd
(Balancing figure)
Folio
Rs.
10,000
85,000
95,000
Steps explained
a.
Before considering the Balancing Figure, the total of debit side is Rs. 95,000 and the
total of credit side is Rs. 10,000. As such, debit side is heavy.
b.
Difference between both the sides is Rs. 85,000.
c.
As the debit side is heavy, the difference of Rs. 85,000 is put on the credit side.
Trial Balance
Trial Balance is the summary of all the balances in all the accounts listed in the General
Ledger and Cash / Bank Book of an organization at any given date. Tallying of the Trial
Balance is the evidence of the fact that all the transactions have properly been posted in the
General Ledger. As such, tallying of Trial Balance generally ensures the arithmetical accuracy
of the process of Ledger Posing.
41
Format of Trial Balance

Trial Balance as on 31st March 2002
Name of the Account
Debit
Credit
For the preparation of Trial Balance, all the accounts in the General Ledger need to be balanced
to ascertain the Closing Balance. Similarly, Cash Book / Bank Book is also required to be
balanced to ascertain the Closing Balance. Accounts having the Debit Balance are shown on
the Debit Side whereas the accounts having the Credit Balance are shown on the Credit Side.
Generally, accounts of the assets will have Debit Balance and hence will be shown on Debit
Side. Generally, accounts of all liabilities will have Credit Balance and hence will be shown on
Credit Side. Generally, accounts of all the Expenses will have Debit Balance and hence will be
shown on Debit Side. Generally, accounts of all the Incomes will have Credit Balance and
hence will be shown on Credit Side.
PREPARATION OF FINAL ACCOUNTS FROM TRIAL BALANCE
Preparation of the financial statements is the basic objective of financial accounting. These
financial statements are basically in two forms
42
a.
Profitability Statement This financial statement is referred to as Profit and Loss

Account in more technical language. The purpose of this financial statement is to disclose
the result of operations of the business transactions during a given period of time. As
such, by nature Profit & Loss Account is a period statement which relates to a specific
duration of time. Hence, Profit and Loss Account is always referred to as Profit and
Loss Account for the year ended on 31st March 2002.
b.
Balance Sheet The purpose of this financial statement is to disclose the financial
status of the organization in terms of its assets and liabilities at any given point of time.
Thus, in simple language, Balance Sheet is a listing of the assets and liabilities of an
organization at any given point of time. Whichever sources are used by an organization
for raising the required amount of funds create an obligation or liability for the organization
and whichever ways the funds are used or applied by an organization create the properties
or assets for the organization. Hence, in practical circumstances, the liabilities are referred
to as Sources of Funds and the assets are referred to Application of Funds. As such,
by nature Balance Sheet is a position statement in the sense it relates to a specific
point of time or date. Hence, Balance Sheet is always referred to as Balance Sheet as
on 31st March 2002.
PROFIT AND LOSS ACCOUNT

As stated earlier, Profit and Loss Account is prepared to disclose the result of operation of the
business transactions during a certain duration of time. In technical language, Profit and Loss
Account may have following four components
a.
Manufacturing Account This part of Profit and Loss Account discloses the result of
manufacturing operations carried out by the organization. The final result disclosed by
the Manufacturing Account is the Cost of Production incurred by the organization.
Following is the specimen of Manufacturing Account.
Manufacturing Account for the year ended on 31st March 2002
Particulars
Amount
Particulars
Amount
Opening Stock
Closing Stock
Raw Material
Raw Material
Work in Progress
Work in Progress
Purchases of Raw Material
Cost of Production
Carriage Inward
(Transferred to Trading Account)
Wages Paid
Power and Fuel
Consumable Stores
Manufacturing Expenses
Depreciation on Production
Assets
Total
b.
Total
Trading Account This part of Profit and Loss Account discloses the result of trading
operations carried out by the organization. The final result disclosed by the Trading
Account is the Gross Profit earned by the organization. Following is the specimen of
Trading Account.
43
Trading Account for the year ended on 31st March 2002

Particulars
Amount
Opening Stock
Finished Goods
Particulars
Amount
Sales (Net of Sales Returns)
Closing Stock
Finished Goods
Cost of Production
(Brought from Manufacturing A/c)
Gross Profit
Total
c.
Total
Profit and Loss Account This part of Profit and Loss Account discloses the final
result of business transactions of the organization. The final result disclosed by the
Profit and Loss Account is the Profit After Tax (PAT) earned by the organization. Following
is the specimen of Profit and Loss Account.
Profit & Loss Account for the year ended on 31st March 2002
Particulars
Administrative Expenses
Office Salaries
Postage & Telephone
Traveling & Conveyance
Legal Charges
Office Rent
Depreciation
Audit Fees
Insurance
Repairs & Renewals
Selling & Distribution Expenses

Advertisement
Carriage Outward
Amount
Particulars
Amount
Gross Profit b/fd

Other Income
Discount Received
Commission Received
Non-Trading Income
Interest Received
Rent Received
Abnormal Income
Profit on the sale of assets
Free Samples
Bad Debts
Sales Commission
44
Particulars
Financial Expenses
Interest & Bank Charges
Amount
Particulars
Amount
Other Expenses
Loss on the sale of assets
Salary to Working Partners
Interest on Capital
Provision for Taxation
Net Profit after Taxes
(Transferred to Capital Account)
Total
d.
Total
Profit and Loss Appropriation Account This part of Profit and Loss Account, which
is mainly applicable to company form of organization, discloses the manner in which the
PAT earned by the organization is appropriated. The amount of profit not appropriated or
retained is transferred to Reserves and Surplus in the Balance Sheet. Following is the
specimen of Profit and Loss Appropriation Account.
Profit & Loss Appropriation Account for the year ended on 31st March 2002
Particulars
Amount
Particulars
Amount
Dividend Paid
Profit After Tax b/fd
Transferred to Reserves
Amount withdrawn from Reserves
Balance transferred to Balance Sheet
Total
Total
BALANCE SHEET
As stated earlier, the purpose of preparing the Balance Sheet is to disclose the financial
status of the organization in terms of its assets and liabilities at any given point of time. As
such, the Balance Sheet has two sides
a.
Liabilities
b.
Assets
45
Liabilities
Credit balances in all the Personal and Real Accounts appear on Liabilities side. Following
items may appear on the liabilities side
a.
Capital
Capital indicates the amount of funds contributed by the owners of the business to the
requirement of funds of the business. As owner of the business is considered to be a
separate entity than the business itself, any amount contributed by the owner is a liability
for the business. Similarly, any amount of profit earned in the past which is not distributed
to the owner also belongs to the owner and becomes a part of the capital.
b.
Long Term Liabilities

This indicates the liabilities which are to be paid off over a longer span of time say 5 to 10
years. In practical circumstances, it may consist of long-term loan borrowed from banks
or financial institutions.
c.
Current Liabilities
This indicates the liabilities which are supposed to be paid off within a very short span of
time say one year. In practical circumstances, it may consist of the flowing items
1.
Sundry Creditors Amounts payable to the suppliers of goods and/or services.
2.
Advances received from customers This amount may not be paid back to the
customers. It gets adjusted with the final selling price. Till it is adjusted with the
selling price, it appears as a current liability.
3.
Outstanding Expenses This amount indicates the expenses already incurred

during the relevant period but not paid for.
4.
Income Received in Advance
5.
Liability for taxes
Assets
Debit balances in all the Personal and Real Accounts appear on Asset side. Following items
may appear on the assets side
a.
Fixed Assets
As stated earlier, fixed assets indicate the value of infrastructural properties acquired by
the business where the benefits are likely to be received over a longer duration of time.
Fixed assets are the assets which are not supposed to be sold, but they are supposed
to be used to do the business to earn the profits. Some of the fixed assets which can be
found in practical circumstances are Land, Building, Machinery, Furniture, Vehicles, and
Computers etc.
46
b.
Investments
This indicates the amount of funds invested by the organization outside the business.
c.
Current Assets
Current Assets are the assets which are likely to be converted in the form of cash or
likely to be consumed during the normal operating cycle of the business within a very
short span of time say one year. The purpose of holding the current assets is to sell the
current assets or use them during the normal course of operations. Current assets
change their form very frequently while doing the business. Some of the current assets
which can be found in practical circumstances are Stock, Sundry Debtors, Cash & Bank
Balances, Prepaid Expenses etc.
Following is the specimen of Balance Sheet.

Balance Sheet as on 31st March 2002
Capital & Liabilities
Capital
Amount
Assets & Properties

Fixed Assets
Amount
Land
Building
Machinery
Furniture
Vehicles
Long Term Liabilities

Loan from Bank
Current Liabilities
Sundry Creditors
Advance from Customers
Outstanding Expenses
Computers
Investments
Current Assets
Stock
Sundry Debtors
Cash Balance
Bank Balance
Prepaid Expenses
Total
Total
Adjustments
While preparing the final accounts from the Trial Balance, it should be remembered that the
Trial Balance might not reflect all the transactions which have the impact on profitability for the
relevant period or the state of affairs of the organization on a particular date. As such, before
preparing the final accounts, the effect of such transactions needs to be considered. The
same is done by passing the Adjustment Entries. Thus, the effect of Adjustment Entries is yet
47
to be reflected in the Trial Balance. As such, according to the Double Entry principles, the
Adjustment Entries always have two effects. Following are some of the main adjustment
entries made while preparing the final accounts from the Trial Balance.
a.
Closing Stock
This indicates the amount of stock in hand on the date of Balance Sheet. The basic
principle on which the closing stock is valued is at cost or market price whichever is
less. Accordingly, the first effect of the closing stock is that it is shown on the credit side
of Manufacturing and/or Trading Account and the second effect is that it is shown on
Balance Sheet Asset side. The Journal Entry passed for this is
Closing Stock A/c Dr.
To, Trading Account
b.
Depreciation
This indicates the reduction in the value of fixed assets due to wear and tear. As the
basic cost of the fixed assets is not transferred to Profit and Loss Account, this adjustment
is necessary to reflect the cost for the use of fixed asset during the year. Accordingly,
the first effect of the adjustment for Depreciation is that the amount is debited to Profit &
Loss Account reducing the profit or increasing the loss and the second effect is that the
corresponding amount is reduced from the value of fixed asset in the Balance Sheet. In
other words, the value of fixed assets in the Balance Sheet is net of depreciation. The
Journal Entry passed for this is
Depreciation A/c Dr.
To, Fixed Asset A/c
c.
This indicates the amount of expenses pertaining to the relevant period which are not
paid during the said period. According to Matching Principle of Accounting, income for a
certain period needs to be compared with the expenses for the same period, whether it
is paid for or not. Accordingly, the first effect of this adjustment is that the corresponding
amount of expenses are increased reducing the profit or increasing the loss and the
second effect is that the corresponding amount is shown as Current Liability on the
Balance Sheet liabilities side. The Journal Entry passed for this is
Expenses A/c Dr.
To, Outstanding Expenses A/c
48
d.
Prepaid Expenses
This indicates the amount of expenses pertaining to the next period which are paid in
advance during the relevant period. According to Matching Principle of Accounting, income
for a certain period needs to be compared with the expenses for the same period.
Accordingly, the first effect of this adjustment is that the corresponding amount of
expenses are reduced, thus increasing the profit or reducing the loss and the second
effect is that the corresponding amount is shown as Current Asset on the Balance Sheet
Asset side. The Journal Entry passed for this is
Prepaid Expenses A/c Dr.
To, Expenses A/c
e.
Accrued Income
This indicates the amount of income for the current period which is not received during
the current period. According to Matching Principle of Accounting, income for a certain
period needs to be compared with the expenses for the same period. Accordingly, the
first effect of this adjustment is that the corresponding amount of income is increased,
thus increasing the profit or reducing the loss and the second effect is that the
corresponding amount is shown as Current Asset on the Balance Sheet Asset side. The
Accrued Income A/c Dr.
To, Income A/c
f.

This indicates the amount of income for the next period which is received during the
current period. According to Matching Principle of Accounting, income for a certain
period needs to be compared with the expenses for the same period. Accordingly, the
first effect of this adjustment is that the corresponding amount of income is reduced,
thus reducing the profit or increasing the loss and the second effect is that the
corresponding amount is shown as Current Liability on the Balance Sheet Liabilities
side. The Journal Entry passed for this is
Income A/c Dr.
To, Income received in advance A/c
g.
Bad Debts
This indicates the unrecoverable amount from the customers on account of credit sales
made to them. If the customer is not likely to pay the amount due from him, the same is
written off as Bad Debts. Accordingly, the first effect of this adjustment is that the amount
49
of Bad Debts is debited to Profit and Loss Account, thus reducing the profits or increasing
the losses and the second effect is that the amount of Sundry Debtors is reduced. The
Bad Debts A/c Dr.
To, Sundry Debtors
h.
Provision for Doubtful Debts

Provision for doubtful debts is necessary due to the possibility that all the customers to
whom the credit sales have been made may not pay the entire amount. Accordingly, the
first effect of this adjustment is that the amount equivalent to the provision for doubtful
debts is written off to Profit and Loss Account and the second effect is that the
corresponding amount is reduced from the Sundry Debtors in the Balance Sheet. It
should be noted that if the provision for bad and doubtful debts is to be maintained at a
certain percentage of Sundry Debtors and if the provision to some extent has already
been made in the books of account, the differential amount only needs to be debited to
Profit and Loss Account. The Journal Entry passed for this is
Profit and Loss Account Dr.
To, Sundry Debtors A/c
i.
Provision for Discount on Debtors

In some cases it is necessary to allow cash discount to the customers for making the
early payment. As the amount of debtors who are likely to avail the cash discount is not
known in advance, a provision is made in the books of account for the discount to be
allowed to debtors. Accordingly, the first effect of this adjustment is that the amount
equivalent to the provision for discount on debtors is written off to Profit and Loss Account
and the second effect is that the corresponding amount is reduced from the Sundry
Debtors in the Balance Sheet. The Journal Entry passed for this is
Profit and Loss Account Dr.
To, Sundry Debtors A/c
j.
Interest on Capital
In order to calculate the profit earned by the organization properly, in some cases interest
may be provided on the amount of capital introduced by the proprietor or partner in the
business. It may not be out of place to mention here that in case of partnership firms,
interest on capital is considered to be an allowable expenditure for calculating the tax
liability as per the provisions of Income tax Act, 1961 if it is payable to the Working
Partners at the rate which is not exceeding 12% p.a. Accordingly, the first effect of this
50
adjustment is that the amount of Interest on Capital is debited to Profit and Loss Account,
thus reducing the profits or increasing the losses and the second effect is that the
corresponding amount is credited to the Capital Account of proprietor or partner. The
Interest on Capital A/c Dr.
To, Capital A/c
k.
Drawings
This represents the amount of cash or value of goods withdrawn by the proprietor or
partner for personal use. If the amount is withdrawn in cash, the same may be entered in
the books of account regularly and thus will be reflected in the Trial Balance. However,
the value of goods withdrawn by the proprietor or partner may be required to be considered
by way of adjustment. Accordingly, the first effect of this adjustment is that the amount
of Sales will be increased, thus increasing the profits or reducing the loss and the second
effect is that the corresponding amount will be debited to the Capital Account of the
proprietor or partner. The Journal Entry passed for this is
Drawing / Capital A/c Dr.
To, Sales A/c
l.
Deferred Revenue Expenditure Written Off

This represents that part of Deferred Revenue Expenditure, returns equivalent to which
are received during the current period. Accordingly, the first effect of this adjustment is
that the deferred revenue expenditure written off will be debited to Profit and Loss Account,
thus reducing the profit or increasing the loss and the second effect is that the
corresponding amount will be reduced from the Asset side of the Balance Sheet. The
Deferred Revenue Expenditure Written Off A/c Dr.
To, Deferred Revenue Expenditure A/c
It should be noted that Deferred Revenue Expenditure Written Off Account is a Nominal
Account whereas Deferred Revenue Expenditure Account is a Real Account.
m.
Abnormal Loss due to fire etc.

In some cases, the organization incurs the loss of stock due to some abnormal events
like fire, earthquake etc. Accordingly, the first effect of this adjustment is that the Trading
Account is credited with the cost of goods lost due to fire, earthquake etc. and the
corresponding amount is debited to Profit and Loss Account as Loss due to Fire Account.
The Journal Entry passed for this is
51
Loss due to Fire Account Dr.

To, Stock Destroyed Account
In some cases, the stock held by the organization is insured with the Insurance Company.
After the abnormal event like fire or earthquake takes places, the insurance company
settles the claim, either in full or in part. The actual loss incurred by the organization is
to the extent of difference between the cost of goods destroyed and the amount of claim
settled by the insurance company. In such event, the amount of claim settled by the
insurance company is debited to the Insurance Companys Account and only the net
amount of loss is debited to Profit and Loss Account. The Journal Entry passed for this
is
Insurance Company A/c Dr.
Loss due to Fire A/c Dr.
To, Stock Destroyed A/c
n.
Goods Distributed as Free Samples

This represents the value of goods distributed as free samples as a part of sales promotion
effort of the organization. This is in the form of advertisement. Accordingly, the first effect
of this adjustment is that the amount of goods distributed as free samples is debited to
Profit and Loss Account, thus reducing the profits or increasing the losses and the
second effect is that the amount of Sales is increased thus increasing the profit or
reducing the loss. The Journal Entry passed for this is
Advertisement A/c Dr.
To, Sales A/c
o.
Goods sent on approval basis

Goods sent to the customers on approval basis should not be treated as the sales till the
goods are finally approved by the customers or the period as agreed upon by both the
parties is over. This is due to the fact that the property in the goods is not transferred until
the said period is over. If the amount of such goods sent on approval basis is treated as
the sales, the effect of this entry needs to be reversed. At the same time, the closing
stock needs to be increased by the cost of such goods sent on approval basis.
p.
Commission payable to the manager

In some cases, commission is payable to the manager as a percentage of profit earned
by the business. The calculation of this commission may be made in two ways
l
52
As a percentage of profit before charging such commission to Profit and Loss

Account.
As a percentage of profit after charging such commission to Profit and Loss Account.
In both the cases, the amount of profit needs to be calculated before the commission is
calculated and then the amount of commission is calculated based upon the methods to
be used for calculating the same. The journal Entry passed for this is
Commission A/c Dr.
To, Commission Payable A/c
Illustration 1
From the following particulars in respect of M/s Pam Industries, Journalize the following
transactions, post them to the ledger, prepare the trial balance and prepare the final accounts.
Date
Particulars
March
2002
1
Started business with the capital of Rs. 50,000
Opened a Bank Account by paying Rs. 35,000
Purchased goods from Ajay on credit Rs. 20,000
Sold the goods to Vijay on credit Rs. 14,000
Paid Ajay by cheque Rs. 19,500 in full settlement
Received Rs. 13,000 from Vijay in full settlement by cheque
15
Purchased furniture of Rs. 10,000 and paid the amount by cheque
18
Paid for traveling expenses in cash Rs. 3,000
21
Sold the goods to Vinod for cash Rs. 10,000
25
Goods purchased from Ashok against cash Rs. 8,000
27
Cash deposited in bank Rs. 5,000
28
Amount withdrawn by cheque for personal purpose Rs. 3,000
30
Paid salary in cash Rs. 2,000
Adjustments
a.
Value of goods unsold on 31st March 2002, valued at cost, Rs. 17,000
b.
Depreciate furniture @2%
c.
Telephone bill for the month of March 2002 not yet paid Rs. 1,500
53
Solution
In the books of M/s Pam Industries
Date
March 2002
1
15
18
21
25
27
28
30
54
Particulars
L.F.
Debit Rs.
Cash A/c Dr.

To, Capital A/c
(Capital introduced in the business)
Bank A/c Dr.
To, Cash A/c
(Opened Bank Account)
Purchases A/c Dr.
To, Ajay A/c
(Goods purchased on credit)
Vijay A/c Dr.
To, Sales A/c
(Sold goods on credit)
Ajay A/c Dr.
To, Bank A/c
To, Discount A/c
(Paid Ajay in full settlement)
Bank A/c Dr.
Discount A/c Dr.
To, Vijay A/c
(Received from Vijay in full settlement)
50,000
Furniture A/c Dr.

To, Bank A/c
(Furniture purchased against cheque)
10,000
Traveling Expenses A/c Dr.

To, Cash A/c
(Paid for traveling expenses)
Cash A/c Dr.
To, Sales A/c
(Sold goods for cash)
Credit Rs.
50,000
35,000
35,000
20,000
20,000
14,000
14,000
20,000
19,500
500
13,000
1,000
14,000
10,000
3,000
3,000
10,000
10,000
Purchases A/c Dr.

To, Cash A/c
(Goods purchased for cash)
8,000
Bank A/c Dr.

To, Cash A/c
(Cash deposited in bank)
5,000
Drawings A/c Dr.

To, Bank A/c
(Withdrawn for personal purpose)
3,000
Salary A/c Dr.

To, Cash A/c
(Paid salary in cash)
2,000
8,000
5,000
3,000
2,000
General Ledger of M/s Pam Industries for March 2002

Cash Account
Date
1
21
Particulars
Folio
To Capital A/c
To Sales
Rs.
50,000
10,000
Date
Particulars
Folio
Rs.
2
18
By Bank
By Traveling Exp.
35,000
3,000
25
By Purchases
8,000
27
30
By Bank
By Salary
5,000
2,000
31
By Balance c/fd
7,000
60,000
60,000
Bank Account
Date
Particulars
Folio
Rs.
Date
Particulars
Folio
Rs.
To Cash A/c
35,000
By Ajay
19,500
To Vijay
13,000
15
By Furniture
10,000
27
To Cash
5,000
27
31
By Drawings
By Balance c/fd
3,000
20,500
53,000
53,000
Purchases Account
Date
Particulars
3
25
To Ajay
To Cash
Folio
Rs.
20,000
8,000
Date
31
Particulars
Folio
By Trading A/c
Rs.
28,000
28,000
28,000
Sales Account
Date
Particulars
31
To Trading A/c
Folio
Rs.
Date
24,000
Particulars
Folio
Rs.
By Vijay
14,000
By Cash
10,000
24,000
24,000
Traveling Expenses Account

Date
18
Particulars
To Cash
Folio
Rs.
3,000
3,000
Date
31
Particulars
By Profit & Loss A/c
Folio
Rs.
3,000
3,000
55
Salary Account
Date
30
Particulars
Folio
To Cash
Rs.
2,000
Date
31
Particulars
Folio
Rs.
2,000
2,000
2,000
Telephone Expenses Account

Date Particulars
31
Folio
Rs.
1,500
To Outstanding Exp.
Date
31
Particulars
Folio
Rs.
1,500
1,500
1,500
Discount Account
Date
9
Particulars
Folio
To Vijay
Rs.
1,000
Date
7
Particulars
Folio
Rs.
By Ajay
500
500
1,000
1,000
Depreciation Account
Date
Particulars
31
To Furniture
Folio
Rs.
Date
200
31
Particulars
Folio
Rs.
200
200
200
Ajay Account
Date
Particulars
To Bank
To Discount
Folio
Rs.
19,500
Date
3
Particulars
Folio
By Purchases
Rs.
20,000
500
20,000
20,000
Vijay Account
Date
5
Particulars
To Sales
Folio
Rs.
14,000
14,000
56
Date
Particulars
By Bank
By Discount
Folio
Rs.
13,000
1,000
14,000
Capital Account
Date
Particulars
28
To Bank
31
To Balance c/fd
Folio
Rs.
3,000
Date
1
Particulars
Folio
By Cash
Rs.
50,000
47,000
50,000
50,000
Outstanding Expenses Account

Date
31
Particulars
Folio
To Balance c/fd
Rs.
1,500
Date
31
Particulars
Folio
By Telephone Exp.
Rs.
1,500
1,500
1,500
Furniture Account
Date
15
Particulars
To Bank
Folio
Rs.
10,000
Date
Particulars
31
By Depreciation
31
By Balance c/fd
Folio
Rs.
200
9,800
10,000
10,000
Trial Balance as on 31st March 2002

Name of the Account
Debit
Cash
7,000
Bank
20,500
Purchases
28,000
Sales
24,000
Traveling Expenses
3,000
Salary
2,000
Telephone Expenses
1,500
Depreciation
200
Discount
500
Capital
47,000
Furniture
9,800
1,500
Total
Credit
72,500
72,500
57

Particulars
Amount
Opening Stock
Nil
Purchases
28,000
Gross Profit c/fd
13,000
Total
Particulars
Amount
Sales
24,000
Closing Stock
17,000
41,000
Total
41,000
Particulars
Amount
Traveling Expenses
3,000
Salary
2,000
Telephone Expenses
1,500
Discount
500
Depreciation
200
Profit carried to Capital Account
Particulars
Amount
Gross Profit b/fd
13,000
5,800
Total
13,000
Total
13,000

Amount
Capital
Assets & Properties
Amount
Fixed Assets
Balance
47,000
Add : Profit for year
5,800
Furniture
10,000
Less : Depreciation
200
52,800
9,800
Current Assets
Current Liabilities
1,500
Total
58
54,300
Stock
17,000
Cash
7,000
Bank
20,500
Total
54,300
Illustration 2
From the following balances and information, prepare Trading and Profit & Loss Account of Mr. X for
the year ended 31st March 1998 and a Balance Sheet as on that date.
Particulars
Xs Capital Account
Dr. Rs.
Plant and Machinery
3,600
Depreciation on Plant and Machinery

Repairs to Plant
400
520
Wages
5,400
Salaries
Income Tax of Mr. X
2,100
100
Cash in Hand and at Bank
400
Land and Building

Depreciation on Building
14,900
500
Purchases
25,000
Purchase returns
Sales
300
49,800
Bank Overdraft
Accrued Income
Salaries Outstanding
Bills Receivable
760
300
400
3,000
Provision for Bad Debts

Bills Payable
Bad Debts
Discount on Purchases
Debtors
1,000
1,600
200
708
7,000
Creditors
Opening Stock
Cr. Rs.
10,000
6,252
7,400
70,820
70,820
Information
a.
Stock as on 31st March 1998 was Rs. 6,000
b.
Write off further Rs. 600 for bad Debt and maintain a provision for bad Debts at 5% on
Debtors.
c.
Goods costing Rs. 1,000 were sent to customer for Rs. 1,200 on 30th March 1998 on
sale or return basis. This was recorded as actual sales.
d.
Rs. 240 paid as rent of the office were debited to Landlord Account and were included in
the list of Debtors.
59
e.
General Manager is to be given commission at 10% of net profits after charging the
commission of works manager and his own.
f.
Works manager is to be given commission at 12% of net profits before charging the
commission of General Manager and his own.
Solution
Particulars
Amount
Opening Stock
Purchases
7,400
25,000
Less : Returns
300
Wages
Amount
Sales
49,800
Less : Goods on approval
1,200
48,600
Closing Stock
6,000
Add : Goods on approval
1,000
7,000
Total
55,600
24,700
5,400
Gross Profit c/fd
Particulars
18,100
Total
55,600
Particulars
Amount
Salaries
Depreciation on Plant
2,100
400
Depreciation on Building
500
Repairs to Plant
Rent
520
240
Bad Debts
Particulars
Amount
Gross Profit b/fd

Discount
18,100
708
200
Add : Additional Bad Debts 600

Add : Provision for Bad Debts 248
Less : Existing Provision
1000
Commission to Works Manager
1,800
Commission to General Manager
1,200
Profit transferred to Capital A/c

Total
60
48
12,000
18,808
Total
18,808

Amount
Capital
Assets & Properties
Amount
Fixed Assets
Balance
10,000
Plant & Machinery
12,000
Building
Less : Income Tax
100
3,600
14,900
21,900
Current Liabilities
18,500
Current Assets
Creditors
6,252
Closing Stock (Including stock on
Bills Payable
1,600
Approval)
Overdraft
760
Cash
Outstanding Salaries
400
Debtors
Commission Payable
3,000
Less : Bad Debts
7,000
400
7,000
600
1,200
Less : Due from Landlord
240
4,960
Less: Provision for Bad Debt 248
4,712
Bills Receivables
3,000
Accrued Income
Total
33,912
300
Total
33,912
Working Notes :
Rs.
Profit before calculating the commission
Commission payable to Works Manager @12%

Commission payable to General Manager on
Commission payable to General Manager @10%
15,000
1,800
13,200
1,200
(Calculated as 13200 / 110 x 100)

Illustration 3
The following Trial Balance is of Shri Om as on 31st March 1991. You are requested to prepare
the Trading and Profit & Loss Account for the year ended 31st March 1991 and a Balance
Sheet as on that date after making the necessary adjustments.
61
Particulars
Dr. Rs.
Sundry Debtors
5,00,000
Sundry Creditors
2,00,000
Outstanding Liabilities for Expenses
55,000
Wages
1,00,000
Carriage Outwards
1,10,000
Carriage Inwards
50,000
General Expenses
70,000
Cash Discount
20,000
Bad Debts
10,000
Motor Car
2,40,000
Printing and Stationery
15,000
Furniture and Fittings
1,10,000
Advertisement
85,000
Insurance
45,000
Salesmans Commission
87,500
Postage and Telephones
57,500
Salaries
1,60,000
Rates and Taxes
25,000
Drawings
20,000
Capital Account
Purchases
Cr. Rs.
14,43,000
15,50,000
Sales
19,87,500
Stock as on 1st April 1990
2,50,000
Cash at Bank
60,000
Cash in Hand
10,500
36,30,500
36,30,500
The following adjustments are to be made
62
a.
Stock as on 31st March 1991 was valued at Rs. 7,25,000.
b.
A provision for Bad and Doubtful Debts are to be made to the extent of 5% on Sundry
Debtors.
c.
Depreciate Furniture & Fixture by 10% and Motor Car by 20%.
d.
Shri Om had withdrawn goods worth Rs. 25,000 during the year.
e.
Sales include goods worth Rs. 75,000 sent out to Santi & Company on approval and
remaining unsold on 31st March 1991. The cost of the goods was Rs. 50,000.
f.
The salesman was entitled to a commission of 5% on total sales.
g.
Debtors include Rs. 25,000 bad debts.
h.
Printing and Stationery expenses of Rs. 55,000 relating to 1989-90 had not been provided
in that year but were paid in this year by debiting outstanding liabilities.
i.
Purchases include purchases of furniture worth Rs. 50,000.
Solution
Particulars
Amount
Opening Stock
2,50,000 Sales
Purchases
Less : Furniture purchased
1550000
50000
Wages
Particulars
Amount
1987500
75000
Closing Stock
725000
1,00,000 Add : Goods on approval
50000
Carriage Inwards
50,000
Gross Profit c/fd
8,12,500
Goods withdrawn
Total
19,12,500
15,00,000
27,12,500
7,75,000
25,000
Total
27,12,500
63
Particulars
Amount
Particulars
Salaries
1,60,000 Gross Profit b/fd
Carriage Outwards
1,10,000
Amount
8,12,500
Advertisement
85,000 Loss transferred to Capital A/c
Insurance
45,000
95,625
Postage & Telephones
57,500
Rates & Taxes
44,625
25,000
Bad Debts
10000
Add : Additional Bad Debts
25000
Add : Provision for Bad Debts 20000
55,000
General Expenses
70,000
Cash Discount
20,000
Printing & Stationery
15,000
Depreciation
64,000
Previous Year Expenses
55,000
Total
8,57,125
Total
8,57,125

Amount
Capital
Assets & Properties
Amount
Fixed Assets
Balance
14,43,000 Motor Car
Less : Loss for year
44,625 Less : Depreciation
Less : Drawings
20,000
Less : Goods withdrawn
25,000 Furniture
Add : Purchases
13,53,375 Less : Depreciation
Current Liabilities
240000
48000
1,92,000
110000
50000
16000
1,44,000
Current Assets
Creditors
2,00,000 Closing Stock (Including stock on
Outstanding Commission
8,125
7,75,000
Approval)
Cash at Bank
60,000
Cash in Hand
Debtors
10,500
500000
Less : Bad Debts
25000
75000
400000
Less: Bad Debt Provision
Total
64
15,61,500
20000
3,80,000
Total
15,61,500
Illustration 4
The following is the Trial Balance of Hari as at 31st December 1994
Particulars
Dr. Rs.
Haris Capital Account

Stock as on 1st January 1994
76,690
46,800
Sales
Returns Inwards
Purchases
3,89,600
8,600
3,21,700
Returns Outwards
5,800
Carriage Inward
19,600
Rent and taxes
4,700
Salaries and Wages
9,300
Sundry Debtors
Cr. Rs.
24,000
Sundry Creditors
14,800
Bank Loan @14%
20,000
Bank Interest
Bank Balance
1,100
14,400
8,000
Discount Earned
4,440
Furniture and Fitting
5,000
Discount Allowed
1,800
General Expenses
11,450
Insurance
1,300
Postage and Telegram
2,330
Cash Balance
380
Travelling Expenses
870
Drawings
30,000
5,11,330
5,11,330

a.
Included among the Debtors is Rs. 3,000 due from Ram and included among the Creditors
Rs. 1,000 due to him.
65
b.
Provision for Bad and Doubtful Debts to be created at 5% and for Discount @2% on
Sundry Debtors.
c.
Depreciation on Furniture and Fitting @10% should be written off.
d.
Personal purchases of Hari amounting to Rs. 600 had been recorded in the Purchases
Day Book.
e.
Interest on Bank Loan shall be provided for the whole year.
f.
A quarter of the amount of Printing and Stationary expenses is to be carried forward to

the next year.
g.
Credit Purchase Invoice amounting to Rs. 400 had been omitted from the book.
h.
Stock as on 31st December 1994 was Rs. 78,600.
Prepare Trading and Profit & Loss Account for the year ended on 31st December, 1994 and
the Balance Sheet as on that date.
Solution
Trading Account for the year ended on 31st December, 1994
Particulars
Amount
Opening Stock
Purchases
46,800 Sales
321700
Less : Personal purchases
600
Add : Unrecorded purchases
400
Less : Returns Outwards
5800
Less : Returns Inwards
Amount
389600
8600
Closing Stock
3,81,000
78,600
3,15,700
Carriage Inwards
19,600
Gross Profit c/fd
77,500
Total
66
Particulars
4,59,600
Total
4,59,600
Profit & Loss Account for the year ended on 31st December 1994
Particulars
Amount
Particulars
Amount
Salaries and Wages
9,300 Gross Profit b/fd
77,500
Rent and Taxes
4,700 Discount Earned
4,440
Bank Interest
1100
Add : Outstanding
1700
2,800
14400
Less : Prepaid
3600
10,800
Discount Allowed
1,800
General Expenses
11,450
Insurance
1,300
2,330
Travelling Expenses
870
1,150
Discount on Debtors
437
Depreciation
500
34,503
Total
81,940
Total
81,940
Balance Sheet as on 31st December, 1994

Amount
Capital
Assets & Properties
Amount
Fixed Assets
Balance
76,690 Furniture & Fitting
Less : Personal Purchases
5000
500
Less : Drawings
30,000 Current Assets

Closing Stock
78,600
80,593 Prepaid Printing & Stationary
3,600
Bank Balance
Current Liabilities
Creditors
Add : Unrecorded Purchases
Less : Due to Ram
8,000
Cash in Hand
14800
Debtors
400
1000
Less: Due to Ram

14,200
Outstanding Interest
1,700
1000
1150
21850
Less: Discount
Bank Loan
380
24000
23000
Less: Bad Debt Provision
437
21,413
Total
1,16,493
20,000
Total
4,500
600
1,16,493
67
Illustration 5
From the following trial balance and information, prepare Trading and Profit & Loss Account of
Mr. Rishabh for the year ended 31st march 1999 and a Balance Sheet as on that date.
Particulars
Dr. Rs.
Capital
1,00,000
Drawings
12,000
Land and Building
90,000
Plant and Machinery
20,000
Furniture
5,000
Sales
1,40,000
Returns outwards
Debtors
4,000
18,400
Loan from Gajanand on 1.7.98 @6% p.a.

Purchases
Returns Inward
Carriage
30,000
80,000
5,000
10,000
Sundry Expenses
600
500
Insurance Expenses
1,000
Provision for bad and doubtful Debts
1,000
Provision for Discount on Debtors

Bad Debts
380
400
Profit of textile Department
10,000
Stock of General Goods on 1st April, 1998
21,300
Salaries and wages
18,500
Creditors
Trade Expenses
12,000
800
Stock of Textile Goods on 31st March, 1999
8,000
Cash at Bank
4,600
Cash in Hand
1,280
2,97,380
68
Cr. Rs.
2,97,380
Information
a.
Stock of General Goods on 31st March, 1999 valued at Rs. 27,300.
b.
Fire occurred on 23rd March, 1999 and Rs. 10,000 worth of general goods were destroyed.
The insurance company accepted claim for Rs. 6,000 only and paid the claim money on
10th April, 1999.
c.
Bad Debts amounting to Rs. 400 are to be written off. Provision for bad and Doubtful
Debts is to be made at 5% and for discount at 2%.
d.
Received Rs. 6,000 worth of goods on 27th March ,1999, but the invoice of purchase was
not recorded in Purchase Book.
e.
Rishabh took away goods worth Rs. 2,000 for personal use but no record was made
thereof.
f.
Charge depreciation at 2% on Land and Building, 20% on Plant and Machinery and 5%
on Furniture.
g.
Insurance prepaid amounted to Rs. 200.
Solution
Trading Account for the year ended on 31st March, 1999
Particulars
Amount
Opening stock of General Goods

Purchases
4000
6000
Carriage
Amount
140000
Less : Return Inwards
5000
82,000 Goods withdrawn
1,35,000
2,000
Goods destroyed by fire
10,000
Closing Stock of General Goods
27,300
10,000
Gross Profit c/fd
61,000
Total
21,300 Sales
80000
Less : Return Outwards
Particulars
1,74,300
Total
1,74,300
69
Particulars
Amount
Salaries & Wages
Particulars
Amount
Sundry Expenses
61,000
600 Profit of Textile Department
10,000
500
Insurance
1000
Less : Prepaid
200
Bad Debts
400
Add : Additional Bad Debts
400
Trade Expenses

800 Less : Existing
100
800 Discount on Debtors
342
800 Less : Existing
380
38
Total
71,138
Depreciation
6,050
Loss by Fire
4,000
Interest on Loan
1,350
Profit carried to Capital A/c
900
1000
37,738
Total
71,138
Balance Sheet as on 31st March, 1999

Amount
Capital
Balance
Less : Drawings
Add: Profit for year
Assets & Properties
Amount
Fixed Assets
100000
Land & Building
12000
2000
37738
Loan from Gajanand
90000
Less: Depreciation
1800
Plant & Machinery
20000
4000
Furniture
5000
250
88,200
16,000
4,750
Current Liabilities
Creditors
12000
6000
Current Assets
18,000
Stock of General Goods
27,300
Stock of Textile Goods

Outstanding Interest on Loan
1,350 Sundry Debtors

Less : Bad Debts
8,000
18400
400
18000
Less : Bad Debts Provision
900
17100
Less : Discount
342
4,600
Cash in Hand
1,280
Prepaid Insurance
200
Receivable from Insurance Company

Total
70
1,73,088
16,758
Cash at Bank
Total
6,000
1,73,088
Illustration 6
Hira and Manik are partners in a firm sharing profits and losses in equal proportion. Following
is the Trial Balance as at 31st March, 1989.
Debit Balances
Rs.
Credit Balance
Rs.
Plant & Machinery
50,000
Sales
2,40,000
Opening Stock
30,000
Discount
Purchases
80,000
Sundry Creditors
20,000
Land & Building
85,000
Bills Payable
10,750
Carriage Inwards
1,700
Hiras Loan Account
50,000
Carriage Outwards
2,500
Capital Accounts
2,000
Wages
16,000
Hira
50,000
Sundry Debtors
50,000
Manik
25,000
Salaries
12,000
Furniture
18,000
Trade Expenses
Return Inwards
Advertisement Suspense
Discount
6,000
950
12,500
900
Partners Drawings Hira

Manik
Bills Receivable
3,000
2,000
20,000
Insurance
1,200
Bad Debts
1,000
Cash at Bank
5,000
Total
3,97,750
Total
3,97,750
You are required to prepare Trading and Profit & Loss Account of the firm for the year ended on
31st March 1989 and the Balance Sheet on that date after taking into consideration following
adjustments
a.
Closing Stock Rs. 45,000.
b.
Depreciate Plant @10% and Furniture @20%. Appreciate Land and Building to
Rs. 90,000.
c.
Bad Debts Reserve to be raised to 2.5% on Sundry Debtors.
71
d.
Advertisement Suspense Account to be written off against revenue over five years.
e.
Partners Drawings are to bear interest @10% p.a. Amounts were withdrawn on
31st December, 1988.
f.
Annual charges for insurance Rs. 1,000. Balance represents amount paid in advance.
g.
Hira gave loan to the firm on 30th September, 1988 which carries the interest @6% p.a.
h.
Manik was to be allowed a salary of Rs. 250 per month.
i.
The partners agree to contribute 50% of the distributable profit to the National Defence
Fund.
Solution
Trading Account for the year ended on 31st March, 1989
Particulars
Amount
Particulars
Opening Stock
30,000 Sales
Purchases
80,000 Less : Returns Inwards
Carriage Inwards
Amount
240000
950
1,700 Closing Stock
Wages
2,39,050
45,000
16,000
Gross Profit c/fd
1,56,350
Total
2,84,050
Total
2,84,050
Profit & Loss Account for the year ended on 31st March, 1989
Particulars
Amount
Salaries
Trade Expenses
6,000 Discount Received
Carriage Outwards
2,500 Interest on Drawings
Insurance
Less : prepaid
1200
200
Discount
Amount
1,000
1,56,350
2,000
Hira
75
Manik
50
900
Bad Debts
1,000 Appreciation of Land & Building
Bad Debts Reserve
1,250
Advertisement
2,500
Salary Payable to Manik
3,000
Interest on Loan from Hira
1,500
Depreciation
5,000
8,600
Sub-Total
72
Particulars
40,250
Particulars
Amount
Contribution to National Defence Fund
Particulars
Amount
61,613
Transferred to Capital Account

Hira
30,806
Manik
30,806
Total
1,63,475
Total
1,63,475

Amount
Capital
Assets & Properties
Amount
Fixed Assets
Hiras Capital
50000
Land & Building
30806
Add : Appreciation
5000
3000
Plant & Machinery
50000
Less : Drawings
Less : Interest on Drawings
75
5000
Furniture
18000
Less : Depreciation
Maniks Capital
25000
30806
85000
3600
3000
Closing Stock
Less : Drawings
2000
Sundry Debtors
50000
56,756 Less : Bad Debt Reserve
1250
50
14,400
45,000
Bills receivables
Hiras Loan Account
45,000
Current Assets
Add : Salary
Less : Interest on Drawings
90,000
48,750
20,000
50,000 Cash at Bank
5,000
Prepaid Insurance
200
Current Liabilities
Sundry Creditors
20,000 Advertisement Suspense
Bills Payable
10,750 Less : Transferred to revenue
Interest on Hiras Loan Account
12500
2500
10,000
Total
2,78,350
1,500
Contribution to National Defence Fund
61,613
Total
2,78,350
Illustration 7
Following is the Trial Balance of M/s. Pandit Brothers, a partnership firm, as on
31st March, 1992.
73
Particulars
Dr. Rs.
Cr. Rs.
Capital Account H. Pandit
1,00,000
Capital Account K. Pandit
1,00,000
Drawings H. Pandit
16,000
Drawings K. Pandit
16,000
Buildings
80,000
Furniture
20,000
Purchases
2,00,000
Sales
3,00,000
Stock (1st April, 1991)
50,000
Wages
44,000
Rates and Taxes
1,600
Office Expenses
10,000
Salaries
50,000
Sundry Debtors
25,000
Sundry Creditors
12,000
Cash in Hand
400
Bank Overdraft
29,000
Carriage Inwards
28,000
Total
5,41,000
5,41,000
Following further information relating to the firm is made available
74
a.
Stock at the end of the year on 31st march, 1992 was Rs. 1,14,500
b.
There was a fire in the premises on 26th November, 1991 which damaged a portion of
stock and the loss was estimated at Rs. 17,500.
c.
H. Pandit is in charge of purchases and is to be paid 2.5% commission on such

purchases.
d.
A steel table purchased on 1st February, 1992 for Rs. 3,000 was debited to purchases
account.
e.
K. Pandit who looks after all other business aspects except purchases is entitled to a
commission of 5% on net profits after charging commission on purchases due to H.
Pandit and commission payable to himself.
f.
Depreciation on Buildings @2.5% and on Furniture @10%
g.
Profits or losses are shared equally.

You are required to prepare Trading and Profit & Loss Account for the year ended on 31st
March, 1992 and the Balance Sheet on that date.
Solution
Particulars
Amount
Opening Stock
Purchases
Particulars
Amount
50,000 Sales
3,00,000
200000
Less : Table Purchased
3000
1,97,000 Closing Stock
Wages
44,000
Carriage Inwards
28,000 Stock destroyed by fire
Commission on purchases
1,14,500
17,500
4,925
Gross Profit c/fd
1,08,075
Total
4,32,000
Total
4,32,000
Particulars
Amount
Salaries
Particulars
Amount
Rates and Taxes
1,600
Office Expenses
10,000
Stock destroyed by fire
17,500
Depreciation
1,08,075
4,050
83,150
Commission to K. Pandit
1,187
Profit transferred to Capital Account

H. Pandit
11,869
K. Pandit
11,869
Total
1,08,075
Total
1,08,075
75

Amount
Capital
H. Pandit Capital
Assets & Properties
Amount
Fixed Assets
100000
Building
11869
Add: Commission
4925
Less : Drawings
16000
80000
Less : Depreciation
2000
Furniture
1,00,794 Add : Purchases
3000
Less : Depreciation
K. Pandit Capital
Add: Commission
Less : Drawings
78,000
20000
2050
20,950
100000
11869
Current Assets
1187
16000
Closing Stock
1,14,500
97,056 Sundry Debtors
25,000
Cash in Hand
400
Current Liabilities
Sundry Creditors
12,000
Bank Overdraft
29,000
Total
2,38,850
Total
2,38,850
Note Commission payable to K. Pandit is calculated as below

(108075 83150)
x 5
105
Illustration 8
The following is the Trial Balance of Shri Arihant as on 31st December 1999.
Particulars
Dr. Rs.
Capital
14,00,000
Drawings
75,000
Opening Stock
80,000
Purchases
Freight on purchases
Wages
16,20,000
15,000
1,10,000
Sales
Salaries
76
Cr. Rs.
25,00,000
1,00,000
Particulars
Dr. Rs.
Travelling Expenses
23,000
Miscellaneous Expenses
35,000
27,000
Advertisement Expenses
25,000
13,000
Discounts
7,600
Cr. Rs.
14,500
Bad Debts written off (after adjusting recovery of bad

debts of Rs. 6,000 written off in 1997)
Building
14,000
10,00,000
Machinery
75,000
Furniture
40,000
Debtors
1,50,000
19,000
Creditors
Investments (12% Purchased on 1st October, 1999)
Bank Balance
1,60,000
6,00,000
83,900
40,93,500
40,93,500
Adjustments
a.
Closing Stock Rs. 2,25,000.
b.
Goods worth Rs. 5,000 were taken for personal use but no entry was made in the books.
c.
Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly written off
against Profit & Loss Account. This asset is to be brought into account on
1st January, 1999 taking depreciation at 10% per annum on straight line basis upto
31st December, 1998.
d.
Depreciation Building at 2.5%, Machinery at 10% and Furniture at 10%.
e.
Provision for Doubtful Debts should be 6% on Debtors.
f.
The manager is entitled to a commission of 5% of net profits after charging his commission.
Prepare Trading and Profit & Loss Account for the year ending 31st December, 1999 and a
Balance Sheet as on that date.
77
Solution
Trading Account for the year ended on 31st December, 1999
Particulars
Amount
Opening Stock
Particulars
Amount
80,000 Sales
Purchases
25,00,000
16,20,000
15,000 Goods withdrawn
Wages
5,000
1,10,000
Closing Stock
Gross Profit c/fd
2,25,000
9,05,000
Total
27,30,000
Total
27,30,000
Profit & Loss Account for the year ended on 31st December 1999
Particulars
Amount
Salaries
Amount
9,05,000
Travelling Expenses
23,000 Bad Debts recovered
35,000 Provision for bad Debts
27,000 Less : Existing
25,000 Income from investments
18,000
14,500
Discount
6,000
9000
19000
10,000
7,600
Bad Debts
20,000
Depreciation
40,000
Sub-Total
2,90,600
Commission to Manager
31,567
6,31,333
Total
78
Particulars
9,53,500
Total
9,53,500
Balance Sheet as on 31st December, 1999

Amount
Capital
Balance b/fd
Less : Drawings
Add : Machine capitalized
Assets & Properties
Amount
Fixed Assets
1400000
Building
75000
5000
631333
28000
1000000
Less : Depreciation
25000
Machinery
75000
Add : Capitalized
28000
11000
Furniture
9,75,000
92,000
40000
Less : Depreciation
4000
36,000
Current Liabilities
Sundry Creditors
1,60,000 Investments
Commission to Manager
6,00,000
31,567
Current Assets
Closing Stock
Debtors
2,25,000
150000
Less : Bad Debt Provision
Total
9000
1,41,000
Bank Balance
83,900
Investment Income outstanding
18,000
21,70,900
Total
21,70,900
Note
Value of machine purchased Rs. 35,000.
Depreciation for 1997 and 1998 Rs. 7,000.
Value of machine to be capitalized Rs. 28,000.
Depreciation for 1999 on this machine Rs. 3,500.
79
Illustration 9
Following is the Trial Balance of K as on 31st March, 2000.
Particulars
Dr. Rs.
Capital
8,00,000
Drawings
60,000
Opening Stock
75,000
Purchases
15,95,000
Freight on Purchases
25,000
Wages (11 months up to 29th February, 2000)
66,000
Sales
Salaries
23,10,000
1,40,000
Postage, Telegrams, Telephones
12,000
18,000
30,000
Creditors
Investments
3,00,000
1,00,000
Discount Received
Debtors
Bad Debts
15,000
2,50,000
15,000
8,000
Building
3,00,000
Machinery
5,00,000
Furniture
40,000
Commission on sales
45,000
Interest on Investments
Insurance (Year up to 31st July 2000)
Bank Balance
12,000
24,000
1,50,000
34,45,000
80
Cr. Rs.
34,45,000
Adjustments
a.
b.
Machinery worth Rs. 45,000 purchased on 1st October, 1999 was shown as purchases.
Freight paid on the machinery was Rs. 5,000 which is included in the freight on purchases.
c.
Commission is payable on sales @2.5% on sales.
d.
Investments were sold at 10% profit, but the entire sale proceeds have been taken as
sales.
e.
Write off Bad Debts Rs. 10,000 and create a provision for Doubtful Debts at 5% of
Debtors.
f.
Depreciate building by 2.5% p.a. and Machinery and Furniture at 10% p.a.
Prepare Trading and Profit & Loss Account for the year ended on 31st March, 2000 and the
Balance Sheet on that date.
Solution
Particulars
Amount
Opening Stock
Purchases
75,000 Sales
1595000
Less: Machine Purchased
45000
Freight on Purchases
25000
Less : Freight on Machinery

Wages
Add : Outstanding
5000
Less : Sale of Investments
Amount
2310000
110000
22,00,000
15,50,000
Closing Stock
2,25,000
20,000
66000
6000
Gross Profit c/fd
72,000
7,08,000
Total
Particulars
24,25,000
Total
24,25,000
81
Particulars
Amount
Particulars
Salaries
Amount
7,08,000
Postage, Telegrams, Telephones
15,000
18,000 Interest on Investments
12,000
30,000 Profit on sale of Investments
10,000
Bad Debts
15000
Add : Additional
10000
12000
Less : Existing Provision
8000
Commission on Sales
45000
Add : Outstanding
10000
Insurance
24000
Less : prepaid
8000
Depreciation
25,000
4,000
55,000
16,000
64,000
3,81,000
Total
7,45,000
Total
7,45,000

Amount
Capital
Assets & Properties
Amount
Fixed Assets
Balance b/fd
800000
381000
Less : Drawings
60000
Building
Less: Depreciation
11,21,000 Machinery
Current Liabilities
7500
2,92,500
500000
Add : Purchased
50000
Less: Depreciation
52500
Furniture
40000
Less : Depreciation
Creditors
300000
4000
4,97,500
36,000
3,00,000
Sales Commission outstanding
10,000 Current Assets
Wages Outstanding
6,000 Closing Stock

Debtors
Less : Bad Debts
2,25,000
250000
10000
240000
Less : Bad Debts Provision
12000
Bank Balance
1,50,000
Prepaid Insurance
Total
82
14,37,000
2,28,000
8,000
Total
14,37,000
Illustration 10
From the following particulars extracted from the books of Ganguli, prepare Trading and Profit
& Loss Account for the year ended on 31st March 1994 and Balance Sheet on that date after
making the necessary adjustments.
Debit Balances
Rs.
Opening Stock
23,400
Sales Returns
4,300
Purchases
1,21,550
Credit Balance
Capital
Sales
7,400
Sundry Creditors
Rent
2,850
Loan from Bank @12%
Salaries
4,650
Interest Received

Interest Paid
Cash at Bank
4,000
Investments at 5% on 1.4.93
2,500
3,770
General Expenses
1,960
Audit Fees
350
Fire Insurance Premium
300
1,165
Postage & Telegrams
435
Cash on Hand
190
Drawings
Total
1,495
900
Discount Allowed
Deposits @10% on 1.4.93
725
450
5,600
Travelling Expenses
Discount Received
10,000
1,700
Advertisement
Furniture on 1.4.93
1,44,800
2,900
9,300
12,000
54,050
Purchases Returns
Carriage Inwards
Sundry Debtors
Rs.
15,000
5,000
2,21,370
Total
2,21,370
Adjustments
a.
Value of stock as on 31st March, 1994 is Rs. 39,300. This includes goods returned by
customers on 31st March, 1994 of the value of Rs. 1,500 for which on entry has been
passed in the books.
83
b.
Purchases include furniture purchased on 1st January 1994 for Rs. 1,000.
c.
Depreciation should be provided on furniture @10% p.a.
d.
Bank Loan as on 1st April, 1993 was Rs. 5,000. An amount of Rs. 5,000 was borrowed
on 31st March, 1994.
e.
Sundry Debtors include Rs. 2,000 due from Robert and Sundry Creditors include
Rs. 1,000 due to him.
f.
Interest paid includes Rs. 300 paid on the Bank Loan.
g.
Interest received represents Rs. 100 from the Sundry Debtors and the balance on
investments and deposits.
h.
Provide for interest payable on Bank Loan and for interest receivable on investments and
deposits.
i.
Make a provision for doubtful debts @5% on the balance under Sundry Debtors. No such
provision is necessary for the deposits.
Solution
Particulars
Amount
Opening Stock
Purchases
121550
Less : Purchase Returns
2900
Less : Furniture Purchased
1000
Carriage Inwards
Amount
144800
Less : Goods returned
1500
Less : Sales Returns
4300
1,39,000
1,17,650
9,300
Gross Profit c/fd
27,950 Closing Stock
Total
84
Particulars
23,400 Sales
1,78,300
39,300
Total
1,78,300
Particulars
Amount
Particulars
Amount
Salaries
Rent
2,850 Interest Received
725
1,700 Add : Receivable
1000

Interest paid
450
Add : Interest on Bank Loan
300
Discount received
1,725
1,495
750
Advertisement
5,600
Discount Allowed
3,770
General Expenses
1,960
Audit Fees
27,950
350
300
Travelling Expenses
1,165
Postage & Telegrams
435
Depreciation
115
Reserve for Bad Debts
475
7,050
Total
31,170
Total
31,170

Amount
Capital
Balance
Assets & Properties
Amount
Fixed Assets
54050
Less: Drawings
5000
7050
Furniture
Add : Purchases
900
1000
115
Investments
Loan from Bank
1,785
2,500
10,000
Current Assets
Closing Stock
Current Liabilities
Sundry Debtors
39,300
12000
Sundry Creditors
7400
Less : Due to Roberts
1000
Less : Due to Roberts
1000
6,400 Less : Goods returned
1500
300 Less : Bad Debts reserve
475
Cash on Hand
190
Cash at Bank
4,000
Deposits
15,000
Interest Receivable
Total
72,800
9,025
1,000
Total
72,800
85
QUESTIONS
86
1.
If the Trial Balance does not agree, what steps will you take to ensure that it tallies?
2.
What do you mean by Final Accounts? Explain in brief the structure of Profitability
Statement and Balance Sheet.
3.
What are the various components of Profit and Loss Account ? Explain the purpose of
each component.
4.
How would you deal with the following while preparing the final accounts
a.
Goods lost by fire
b.
Goods distributed as free samples
c.
Goods sent on approval basis
d.
Bad Debts and Provision for Bad Debts
e.
Interest on Capital
f.
Prepaid Expenses and Outstanding Expenses
PROBLEMS
Q.1. The following is the Trial Balance of Shri Paras as on 31st March 1991. You are requested
to prepare the Final Accounts after giving effect to the adjustments.
Particulars
Dr. Rs.
Sundry Creditors
Sundry Debtors
63,000
1,45,000
Capital Account
7,10,000
Drawings
52,450
Insurance
6,000
General Expenses
30,000
Salaries
1,50,000
Patents
75,000
Machinery
2,00,000
Freehold Land
1,00,000
Building
3,00,000
Stock on 1st April 1990
57,600
Carriage on Purchases
20,400
Carriage on Sales
32,000
Fuel and Power
47,300
Wages
1,04,800
Returns Outwards
Returns Inwards
5,000
6,800
Sales
Purchases
Cr. Rs.
9,87,800
4,06,750
Cash at Bank
26,300
Cash in Hand
5,400
17,65,800
17,65,800

a.
Stock as on 31st March, 1991 was valued at Rs. 68,000.
b.
A provision for Bad and Doubtful Debts is to be made to the extent of 5% on Sundry
Debtors.
c.
Depreciate Machinery @10% and Patents @20%.
87
d.
Wages include a sum of Rs. 20,000 spent on erection of a cycle shed for employees and
customers.
e.
Salaries for the month of March 1991 amounting to Rs. 15,000 were unpaid.
f.
Insurance includes a premium of Rs. 1,700 on a policy, expiring on 30th September,

1991.
Q.2. Mr. A, a Shopkeeper had prepared the following trial balance from his ledger as on
31st March 1989.
Particulars
Purchases
Sales
Dr. Rs.
6,20,000
8,30,000
Cash in Hand
4,200
Cash in Bank
24,000
Stock of Goods on 1st April, 1988

Mr. As Capital
Drawings
1,00,000
5,77,200
8,000
Salaries
64,000
Postage and Telephone
23,000
Salesmen Commission
70,000
Insurance
Advertising
18,000
34,000
Furniture
44,000

Motor Car
Bad Debts
Cash Discount
6,000
96,000
4,000
8,000
General Expenses
60,000
Carriage Inwards
20,000
Carriage Outwards
44,000
Wages
Creditors
40,000
Debtors
Cr. Rs.
80,000
2,00,000
14,87,200
14,87,200
You are requested to prepare Trading and Profit & Loss Account for the year ended 31st
March, 1989 and Balance Sheet as on that date. You are also given the following further
information
88
a.
Cost of goods in stock as on 31st March, 1989 Rs. 1,45,000
b.
Mr. A had withdrawn goods worth Rs. 5,000 during the year.
c.
Purchases include purchase of furniture worth Rs. 10,000.
d.
Debtors include Rs. 5,000 Bad Debts.
e.
Creditors include a balance of Rs. 4,000 to the credit of Mr. B in respect of which it has
been decided and settled with the party to pay only Rs. 1,000.
f.
Sales include goods worth Rs. 15,000 sent to Ram & Co. on approval and remaining
unsold as on 31st March 1989 and the cost of goods was Rs. 10,000.
g.
Provision for bad debts is to be created at 5% on Sundry Debtors.
h.
Depreciate furniture by 15% and Motor Car by 20%
i.
The salesmen are entitled to a commission of 10% on total sales.
Q.3. From the following balances extracted from the books of Mr. Yellow, prepare Trading and
Profit & Loss Account for the year ended 31st December, 1990 and a Balance Sheet as
on that date.
Particulars
Purchases
Mr. Yellows Capital Account
Computer at cost
Cash at Bank
Cash on Hand
Sundry Creditors
Bills Payable Account
Furniture & Fittings Account at cost
Rent
Discount Received
Bills Receivables Account
Trade Charges
Sundry Debtors
Sales
Returns Outwards
Drawings Account
Rent Due
Discount
Wages
Salaries
Returns Inwards
Dr. Rs.
71,280
60,000
18,380
4,000
2,836
13,000
10,220
1,540
12,540
22,000
6,720
920
34,156
60,720
11,432
5,200
320
540
1,800
16,780
1,000
1,77,692
Cr. Rs.
1,77,692
89
Adjustments
a.
Closing Stock on 31st December, 1990 was valued at cost Rs. 25,000 (Market Value
Rs. 16,200)
b.
Rs. 6,000 paid to Mr. Red against Bill Payable were debited by mistake to Mr. Greens
Account and included in the list of Sundry Debtors.
c.
Travelling expenses paid to sales representative Rs. 5,000 for the month of December
1990 were debited to his personal account and included in the list of Sundry Debtors.
d.
Depreciation on furniture & fittings shall be provided at 10% per annum.
e.
Provide for doubtful debts at 5% on Sundry Debtors.
f.
Goods costing Rs. 1,500 used by the proprietor.
g.
Salaries include Rs. 12,000 paid to sales representative who is further entitled to a
commission of 5% on net sales.
h.
Stationary charges Rs. 1,200 due on 31st December, 1990.
i.
Purchases include opening stock valued at Rs. 7,000 (cost price)
j.
Sales representative further entitled to an extra commission of 5% on net profit after

charging his extra commission.
k.
No depreciation need to be provided for computer as it had been purchased on

31st December, 1990 and not put to use.
Q.4. From the following trial balance of Hari and additional information, prepare Trading and
Profit & Loss Account for the year ended 31st March, 1995 and a Balance Sheet as on
that date.
Particulars
Dr. Rs.
Capital
Furniture
1,00,000
20,000
Purchases
1,50,000
Debtors
2,00,000
Interest Earned
Salaries
4,000
30,000
Sales
3,21,000
Purchase returns
90
5,000
Wages
20,000
Rent
15,000
Sales Returns
10,000
Bad Debts written off
Cr. Rs.
7,000
Particulars
Dr. Rs.
Creditors
Drawings
Cr. Rs.
1,20,000
24,000

6,000
8,000
Insurance
12,000
Opening Stock
50,000
Office Expenses
12,000
Provision for Depreciation
2,000
5,58,000
5,58,000
Additional Information
a.
Depreciation furniture by 10% on original cost.
b.
A provision for Doubtful Debts is to be created to the extent of 5% on Sundry Debtors.
c.
Salaries for the month of March 1995 amounting to Rs. 3,000 were unpaid which must
be provided for. However, salaries include Rs. 2,000 paid in advance.
d.
Insurance amounting to Rs. 2,000 is prepaid.
e.
Provide for outstanding office expenses Rs. 8,000.
f.
Stock used for private purpose Rs. 6,000.
g.
Closing Stock in Trade Rs. 60,000
Q.5. The following is the Trial Balance of Shri Arihant as on 31st December, 1999.
Particulars
Dr. Rs.
Capital
14,00,000
Drawings
75,000
Opening Stock
80,000
Purchases
Wages
16,20,000
15,000
1,10,000
Sales
Salaries
Cr. Rs.
25,00,000
1,00,000
91
Particulars
Dr. Rs.
Travelling Expenses
23,000
35,000
27,000
25,000
13,000
Discounts
Cr. Rs.
7,600
Bad Debts written off (after adjusting recovery of bad

debts of Rs. 6,000 written off in 1997)
Building
14,500
14,000
10,00,000
Machinery
75,000
Furniture
40,000
Debtors
1,50,000
19,000
Creditors
1,60,000
st
Investments (12% Purchased on 1 October 1999)

Bank Balance
6,00,000
83,900
40,93,500
40,93,500
Adjustments
a.
b.
Goods worth Rs. 5,000 were taken for personal use but no entry was made in the books.
c.
Machinery worth Rs. 35,000 purchased on 1st January, 1997 was wrongly written off
against Profit & Loss Account. This asset is to be brought into account on 1st January
1999 taking depreciation at 10% per annum on straight line basis upto 31st December,
1998.
d.
Depreciation on Building at 2.5%, Machinery at 10% and Furniture at 10%.
e.
Provision for Doubtful Debts should be 6% on Debtors.
f.
The Manager is entitled to a commission of 5% of net profits after charging his commission.
Prepare Trading and Profit & Loss Account for the year ending 31st December, 1999 and a
Balance Sheet as on that date.
Q.6. From the following information, you are required to prepare Trading Account, Profit &
Loss Account and Balance Sheet as on 31st December, 1999 for SANPAT Co.
92
Particulars
Dr. Rs.
Sundry Debtors
40,000
Bills Receivables
Goodwill
18,500
40,500
Land & Building
1,10,000
Plant & Machinery
40,000
Furniture
40,200
Motors
Telephone Bills
50,800
11,200
Opening Stock
18,700
Wages
2,000
Advertisement
11,700
Royalty
Power & Fuel
12,000
12,800
Legal Charges
1,200
Audit Fees
4,090
Lighting
2,000
Salaries
Repairs
3,500
110
Purchases
Rent
Cash in Hand
Cr. Rs.
22,000
1,700
78,000
Depreciation Fund
Outstanding Taxes
8,000
1,800
Bills Payable
2,200
Sundry Creditors
4,700
Bank Overdraft
3,200
Capital
General Reserves
1,50,000
38,000
Bank Loan
1,00,000
Provident Fund
40,000
Purchases Returned
1,000
Sales
Bank Loan
1,20,500
50,400
1,200
5,21,000
5,21,000
93
Adjustments
a.
Interest on Capital 10%.
b.
c.
Goods costing Rs. 8,000 lost by fire and insurance company admitted a claim of
Rs. 6,500.
d.
Depreciation on Motors 10%, Furniture 20%, Plant & Machinery 5%.
e.
Provide RDD 10% on Debtors.
f.
Outstanding Wages Rs. 1,000.
g.
Prepaid Telephone Bill Rs. 1,200.
Q.7. Following Trial Balance was taken out on 31st March, 1996 from the books of Mr. Raman.
You are required to prepare Trading and Profit & Loss Account for the year ended 31st
March, 1996 and Balance Sheet as at that date, after making the necessary adjustments.
Debit Balances
Wages & Salaries
Drawings
Purchases
Sales Returns
Office Furniture
Buildings
Office Expenses
Advertisement
8,000
2,000
18,000
Sales-Credit
Capital
18,000
34,000
300
4,000
12,000
800
500
Rent and Taxes
400
Commission
200
Bills receivables
Travelling Expenses
800
250
Trade Expenses
350
Discount earned
340
Purchases Returns
460
1,500
Sundry Creditors
Bank Overdraft
2,800
1,300
Income from Investments
250
190
11,000
Cash in Hand
Investments
1,800
2,000
Fuel & Power (Factory)
1,060
Total
Rs.
Sales-Cash
5,000
Sundry Debtors
Credit Balances
6,000
Opening Stock
Bad Debts
94
Rs.
66,650
Total
66,650
Adjustments
a.
Depreciation to be provided on Building and Furniture @10%.
b.
Rent outstanding was Rs. 120.
c.
Provision for Doubtful Debts to be maintained at 5%.
d.
Interest accrued but not received was Rs. 50.
e.
Goods of the value of Rs. 100 were given away as free samples.
f.
Closing Stock was valued at Rs. 8,200.
Q.8. From the following Trial Balance and adjustments, prepare Trading and Profit & Loss
Account for the year ending 31st December 1997 and Balance Sheet as on that date.
Debit Balances
Rs.
Salaries
16,500
Bad Debts
1,500
Credit Balances
Commission Received
Sales
Rs.
1,250
1,70,000
Opening Stock
12,500
Interest Received
2,250
Purchases
87,500
1,750
Wages
5,000
Commission Paid
250
Carriage Outwards
2,500
Octroi
7,000
Machinery
25000
Additions on 1.7.97
12500
22,500
Goodwill
25,000
Cash
15,000
Sundry Debtors
52,500
Total
Loan taken on 1.10.97 @12% p.a.
1,00,000
12,500
37,500
Bank
Legal & Professional Fees
Capital
2,500
2,87,750
Total
2,87,750
Adjustments
1.
Closing stock was valued at cost Rs. 37,500.
2.
Outstanding salaries amounted to Rs. 1,500.
3.
Commission received but not earned Rs. 250.
95
Q.9. From the following Trial Balance and adjustments, prepare Trading and Profit & Loss
Account for the year ending 31st December, 1997 and Balance Sheet as on that date.
Debit Balances
Opening Stock
Rs.
25,000
Credit Balances
Rs.
Rent Received
1,500
Wages
5,000
Commission Received
750
Carriage
1,000
Miscellaneous Income
250
Salaries
3,800
Bad Debts recovered
Bad Debts
700
Purchases
1,10,000
Return Inwards
2,000
RDD
Sales
1,000
700
2,00,000
Return Outwards
1,000
7,500
Plant & Machinery
35,000
Bills Payable
Furniture as on 1st January, 1997
20,000
Capital
70,000
Creditors
20,000
Furniture purchased 1.7.1997

Investments
5,000
27,500
Patent Rights
3,500
Cash in Hand
750
Cash at Bank
13,250
Sundry Debtors
40,000
Bills Receivables
10,000
Postage and Telegrams
Total
200
3,02,700
Total
3,02,700
Adjustments
1.
Write off Bad Debts Rs. 500 and create 5% RDD on Debtors.
2.
Salaries Outstanding Rs. 200.
3.
Unearned commission Rs. 50.
4.
Plant & Machinery and Furniture to be depreciated @10% p.a.
5.
Q.10. Melon and Lemon are partners sharing profits equally. From the following Trial Balance
and the additional information, prepare Trading and Profit & Loss Account for the year
ending 30th June, 1982 and Balance Sheet on that date.
96
Debit Balances
Rs.
Drawings - Melon
2,000
- Lemon
3,500
Credit Balances
Capital - Melon
- Lemon
Land & Building
36,000
Sales
Machinery
18,000
Returns
Salaries
Motor Car
3,700
10,500
Trade Expenses
1,900
Carriage Inward
400
Royalties
Purchases
Return Inwards
Debtors
25,000
95,500
1,300
800
Creditors
3,000
Commission
1,500
Bank Loan taken 0n 1.1.82
20,000
45,300
2,500
24,600
1,000
Insurance
1,200
23,800
Advertisement
3,000
Cash at Bank
2,900
Total
35,000
1,800
Discounts
Stock on 1.7.81
Bad Debts Reserve
Rs.
1,82,100
Total
1,82,100
Additional Information
a.
Stock on 30th June, 1982 was worth Rs. 36,000 at cost while its market value was
Rs. 39,000
b.
Goods worth Rs. 4,000 taken by Lemon for personal use were not entered in the books
of accounts.
c.
Of the debtors, Rs. 600 were bad and should be written off and reserve for doubtful debts
should be maintained at 5%.
d.
5% interest is to be allowed on capital.
e.
Provide for interest on bank loan @10% per annum.
f.
Insurance is paid for the year ending 31st December, 1982.
97
Q.11. From the Trial Balance of M/s. Hocus and Pocus, you are required to prepare Trading
and Profit & Loss Account for the year ending 31st December 1982 and the Balance
Sheet as on that date after taking into account the additional information. Partners
share the profits and losses equally.
Debit Balances
Rs.
Credit Balances
Rs.
Drawings Hocus
14,450
Capital Hocus
1,80,000
Drawings Pocus
15,000
Capital Pocus
1,50,000
Sales
4,00,000
Stock as on 1.1.82
Bills Receivables
Purchases
Returns Inwards
Plant and Machinery
Furniture
Sundry Debtors
2,00,000
25,000
61,000
2,75,000
Return Outwards
4,500
5,000
Sundry Creditors
1,40,000
Total
9,35,500
1,00,000
45,000
1,20,000
Cash in Hand and at Bank
77,550
Salaries
12,000
Wages
19,000
Rent and Taxes
11,500
Insurance
3,000
Printing and Stationary
2,000
General Expenses
6,500
Power and Fuel
4,500
Total
Bills Payable
9,35,500
Additional Information.
98
a.
Stock as on 31st December, 1982 was Rs. 1,60,000.
b.
It is discovered that sales effected on 31st December, 1982 of the value of Rs. 2,000 has
not been recorded in the books.
c.
Stock worth Rs. 3,000 uninsured has been destroyed by fire.
d.
Depreciate Plant & Machinery by 20% and Furniture by 5%
e.
Provide for bad and doubtful debts Rs. 6,000.
f.
Outstanding Expenses Salaries Rs. 2,500, Wages Rs. 1,000.
g.
Prepaid insurance Rs. 500.
Q.12. The Accountant of M/s. Kasturi Agencies extracted the following Trial Balance as on
31st March, 1987.
Particulars
Dr. Rs.
Capital
Cr. Rs.
1,00,000
Drawings
18,000
Buildings
15,000
Furniture
7,500
Motor Van
25,000
Bank Loan at 12% Interest
15,000
Interest paid on above
400
Sales
1,00,000
Purchases
75,000
Stock as on 1.4.86
25,000
Stock as on 31.3.87
Establishment Expenses
32,000
15,000
Freight Inwards
2,000
Freight Outwards
1,000
Commission Received
7,500
Sundry Debtors
28,100
Bank Balance
20,500
Sundry Creditors
10,000
2,28,500
2.68,500
The Accountant located the following errors but is unable to proceed further any more.
a.
A totalling error in bank column of payment side of cash book whereby the column was
undercast by Rs. 500.
b.
Interest on Bank loan paid for the quarter ending 31st December, 1986, Rs. 450, was
omitted to be posted in the ledger. There was no further payment of interest.
c.
You are required to set right the Trial Balance and prepare the Trading and Profit and
Loss Account for the year ended on 31st March, 1987 and the Balance Sheet on that
date, after carrying out the following
1.
2.
Depreciation is to be provided on the assets as follows :

l
Buildings 2.5% p.a.
Furniture 10% p.a.
Motor Van 10% p.a.
Balance of interest due on the loan is also to be provided for.
99
NOTES
100
Chapter 4
BANK RECONCILIATION STATEMENT
If the account is opened in a bank in the name of business, the bank periodically gives the
bank passbook or the bank statement. The bank passbook or the bank statement is the
extract of the account in the name of business as it appears in the books of the bank.
Similarly, in the books of business also, it maintains the bank book which is the extract of
bank transactions as it appears in the book of business. As both the bank book in the books
of business and bank passbook as per the books of bank record the same transactions, the
balance as per bank book should match with the balance as per passbook. However, in
reality, the said balances may not match with each other. These balances may not match with
each due to the following reasons
1.
Cheques issued but not debited - The business might have issued some cheques
which are not yet presented in the bank for clearing. As such, the balance as per bank
pass book may be higher.
2.
Cheques deposited but not cleared - The business might have deposited some
cheques in the bank account, but the bank might not have received the payment for the
same and hence the amount is not yet credited to the bank account. As such, balance
as per bank book may be higher.
3.
Other Reasons There may be a possibility that certain items may appear only in the
passbook without any corresponding effect of the same in the bank book. This may be
possible due to following reasons
a.
The bank debits periodical bank charges and bank interest to the account. These
amounts appear only in the bank passbook. The business organization makes the
entry of the same on the receipt of intimation from the bank. Till the entry is passed
in the bank book, the bank book may show higher balance than the passbook.
b.
If the cheques deposited by the business organization get dishonoured, bank

immediately debits the same amount to the account. The business organization
makes the entry of the same on the receipt of intimation from the bank. Till the
entry is passed in the bank book, the bank book may show higher balance than the
passbook.
101
c.
In some cases, some of the customers of the business organization may make the
payment directly in the bank account of the business organization. The business
organization makes the entry of the same on the receipt of intimation from the
bank. Till the entry is passed in the bank book, the bank book may show lower
balance than the passbook.
d.
In some cases, the business organization may give the standing instructions to the
bank to make the recurring payments like rent, electricity bills, telephone bills etc.
as and when they become due for payment. Accordingly, the bank might have paid
these amounts and on payment, they are debited to the account. The business
organization makes the entry of the same on the receipt of intimation from the
bank. Till the entry is passed in the bank book, the bank book may show higher
balance than the passbook.
e.
In some cases, the bank is given the responsibility of collecting the investment
income or the principal amount of investment or the bills of exchanges on the date
of maturity. Accordingly, the bank collects the same and credits the same to the
account. The business organization makes the entry of the same on the receipt of
intimation from the bank. Till the entry is passed in the bank book, the bank book
may show lower balance than the passbook.
f.
There may be some clerical error on the part of bank when certain amounts may be
wrongly debited or credited by the bank to the account. The business organization
makes the entry of the same on the receipt of intimation from the bank. Till the
entry is passed in the bank book, the bank book may show lower or higher balance
than the passbook depending upon the nature of error on the part of bank.
Bank Reconciliation Statement is the statement prepared to explain the reasons as to why
the bank balance as per passbook and bank balance as per bankbook does not match.
Preparation of Bank Reconciliation Statement
The bank reconciliation starts with the Closing Bank Balance as per Bank Book and by
making the additions and subtractions therefrom, the Bank Balance as per the Bank Statement
or Pass Book is arrived at. Alternatively, the bank reconciliation statement may start with
Balance as per the Bank Statement or Pass Book and by making the additions and subtractions
therefrom, the Bank Balance as per the Bank Book may be arrived at. For preparing the bank
reconciliation statement, entries on the payment side of Bank Book are compared with the
withdrawal column of the Pass Book or Bank Statement and the entries on the receipts side
of Bank Book are compared with the deposits column of Bank Statement or Pass Book. If
entries on the payment side or receipt side of the Bank Book appear on the withdrawal or
deposit column of Bank Statement or Pass Book respectively, bank reconciliation statement
102
does not get affected. Bank reconciliation statement is affected due to those amounts which
appear on the payment side of Bank Book but are not there in the withdrawals column of Bank
Statement or Pass Book or amounts which appear on the receipts side of Bank Book but are
not there in the deposits column of Bank Statement or Pass Book.
Following is the specimen of bank reconciliation statement
Bank Reconciliation Statement as on
Bank Balance as per Bank Book
Add :
a. Cheques issued but not presented

b. Amount credited in Pass Book but not in
Bank Book
c. Deposits made in the account directly
d. Wrong credits given by bank
Sub-Total
Less :
a. Cheques deposited but not cleared

b. Interest/Bank Charges debited by bank
c. Direct payments made by bank not entered in
Bank Book
d. Cheques dishonoured not recorded in
Bank Book
e. Wrong debits given by bank
Sub-Total
Bank Balance as per Bank Statement or Pass Book

Following points should be remembered
a.
If the bank reconciliation statement is prepared by starting with Bank Balance as per
Bank Statement or Pass Book, amounts added in the above specimen need to be
subtracted and the amounts subtracted in the above specimen need to be added.
b.
If the bank has given the overdraft facility, generally the Bank Book will show closing
balance as credit balance. If the bank reconciliation statement is prepared starting with
bank balance as per Bank Book, amounts added in the above specimen need to be
subtracted and the amounts subtracted in the above specimen need to be added.
c.
If the bank reconciliation statement prepared discloses the amounts for which the entries
have not been made in the Bank book, those entries should be made in the books of
accounts and the balance as per the Bank book should be modified accordingly.
103
d.
After all the entries as disclosed by the bank reconciliation statement are passed in the
books of account, there will be mainly two amounts appearing in the final bank reconciliation
statement viz. cheques issued but not presented for payment and cheques deposited
but not cleared. In some abnormal circumstances, the final bank reconciliation statement
may have the amounts which are wrongly debited or credited by the bank erroneously for
which the bank needs to pass rectification entries subsequently.
e.
For the purpose of preparation of Trial Balance, bank balance as per Bank Book will be
considered and not the balance as per Bank Statement or Pass Book.
Illustration
Following are the entries recorded in the Bank Column of the Cash Book of Mr. X for the month
ending 31st March 1997.
Cash Book (Bank Column only)
Date
Particulars
15.3.97
To Cash
20.3.97
Date
Particulars
36000
01.3.97
By Balance b/fd
To Roy
24000
04.03.97
By John
22.3.97
To Kapoor
10000
06.3.97
By Krishnan
400
31.3.97
To Balance c/fd
7640
15.3.97
By Kailash
240
20.3.97
By Joshi
35000
Total
77640
Total
Rs.
77640
Rs.
40000
2000
On 31st March, 1997, Mr. X received the Bank Statement. On perusal of the statement, Mr. X
ascertained the following information
a.
Cheques deposited but not cleared by bank Rs. 10,000
b.
Interest on securities collected by the bank but not recorded in cash book Rs. 1,080
c.
Credit transfers not recorded in the cash book Rs. 200
d.
Dividend collected by the bank directly but not recorded in the cash book Rs. 1,000
e.
Cheques issued but not presented for payment Rs. 37,400
f.
Interest debited by the bank but not recorded in the cash book Rs. 1,000
g.
Bank Charges not recorded in the cash book Rs. 340
From the above information you are asked to prepare a Bank reconciliation statement to
ascertain the balance as per Bank Statement.
104
Solution
Bank Reconciliation Statement as on 31st March, 1997
Bank Balance as per Cash Book (Overdraft)
Add :
7,640
10,000
b. Interest debited by bank not recorded in Cash Book
1,000
c. Bank Charges debited by bank not recorded in

Cash Book
340
Sub-Total
Less : a. Cheques issued but not presented
11,340
18,980
37,400
b. Interest on securities collected by bank not

Recorded on cash book
1,080
c. Credit transfer not recorded in cash book
200
d. Dividend collected by bank not recorded in

Cash Book
1,000
Bank Balance as per Bank Statement (Overdraft)
39,680
20,700
Illustration
From the following extracts of the cash book (bank column) and bank pass book of Mr.X,
prepare the bank reconciliation statement for the month ending on 31st March, 1997.
Date
Particulars
01.3.97
To Balance b/fd
03.3.97
Date
Particulars
8,680
02.3.97
By Salaries & Wages
To A
1,200
03.3.97
By Interest on Loan
05.3.97
To B
1,620
08.3.97
By Bank Charges
16.3.97
To C
600
12.3.97
By X
1,500
21.3.97
To Interest
700
21.3.97
By Y
200
24.3.97
To D
1,200
24.3.97
By Z
1,350
28.3.97
To E
3,500
28.3.97
By Drawings
29.3.97
To F
2,200
31.3.97
By Balance c/fd
15,315
31.3.97
To G
2.800
Total
22,500
Total
22,500
Rs.
Rs.
3,250
80
5
800
105
Extracts of Pass Book of Mr. X

In the books of Bank of India, Karve Road Branch, Pune
Date
Particulars
01.4.97
Balance b/fd
02.4.97
To Z
02.4.97
By E
03.4.97
By D
04.4.97
To Insurance Premium
05.4.97
To M
05.4.97
By Cash
06.4.97
By F
06.4.97
To Y
07.4.97
By G
07.4.97
To Interest
Withdrawals
Deposits
Dr/Cr
Balance
Cr
7,165
Cr
5,815
3,500
Cr
9,315
1,200
Cr
10,515
700
Cr
9,815
1,200
Cr
8,615
1,000
Cr
9,615
2,200
Cr
11,815
Cr
11,615
Cr
14,415
Cr
13,915
1,350
200
2,800
500
Solution
Bank Reconciliation Statement as on 31st March 1997
Add :
15,315
Cheques issued but not presented

Mr. Z
1,350
Mr. Y
200
Sub-Total
1,550
16,865
Less : Cheques deposited but not cleared

Mr. E
3,500
Mr. D
1,200
Mr. F
2,200
Mr. G
2,800
9,700
Sub-Total
106
7,165
Illustration
Following particulars are extracted from the books of accounts of Mr. Bose for the month
ending 31st March, 1989.
a.
Bank balance as per cash book Rs. 7,000.
b.
Cheques issued but presented after 31st March, 1989 Rs. 1,000.
c.
Three cheques were issued for Rs. 500, Rs. 1,000 and Rs. 1,500 respectively, but the
cheque for Rs. 1,000 was presented on 3rd April, 1989.
d.
Cheques issued but not recorded in the cash book Rs. 750.
e.
Cheques deposited but credited after 31st March, 1989 Rs. 250.
f.
Three cheques were deposited for Rs. 1,000, Rs. 1,200 and Rs. 1,600 respectively, but
the cheque for Rs. 1,600 was credited on 2nd April.
g.
Cheques deposited into the bank but not recorded in the cash book Rs. 1,000.
h.
Debit side of the cash book was overcast by Rs. 500.
i.
Credit side of the cash book was undercast by Rs. 800.
j.
Bank interest credited for Rs. 150 and debited for interest Rs. 50 not recorded in the
cash book.
k.
Dividend collected by the bank not recorded in the cash book Rs. 1,000.
l.
A debtor directly deposited into bank but not recorded in the cash book Rs. 500.
m.
Rs. 1,000 in respect of dishonoured cheques appeared in the pass book but not in the
cash book.
n.
Bank met a Bill Payable of the firm Rs. 1,500 on 30th March, 1989 under an advice to the
firm on 2nd April, 1989.
o.
Banks charges for a cheque book Rs. 5 were entered in the cash book twice.
p.
A cheque for Rs. 50 drawn by Mr. Mukherjee had been charged to Mr. Boses account in
error in March, 1989.
Prepare the bank reconciliation statement as on 31st March, 1989 before and after making
the necessary adjustments in the cash book.
107
Solution
(Before making adjustments in the cash book)
Add :
7,000
1,000
b. Cheques issued but not presented
1,000
c. Cheques deposited but not recorded in cash book
1,000
d. Bank Interest credited not credited in cash book

e. Dividend collected not entered in cash book
f.
150
1,000
Deposits made in bank not entered in cash book
500
g. Bank charges recorded twice in cash book
Sub-Total
11,655
Less : a. Cheques deposited but not cleared
250
b. Cheques issued but nor recorded in cash book

c. Cheques deposited but not cleared
750
1,600
d. Debit side of cash book overcast
500
e. Credit side of cash book undercast
800
f.
Bank Interest debited not debited in cash book
50
g. Bill paid by bank not entered in cash book
1,500
h. Cheques dishonoured not recorded in cash book
1,000
i.
4,655
Cheque wrongly debited by bank
50
Sub-Total
6,500
5,155

Particulars
Particulars
Rs.
To Balance b/fd
7,000
By Cheques issued
750
To Cheques deposited
1,000
By Debit side overcast
500
By Credit side undercast
800
To Interest Received Account

To Dividend Received Account
To Debtors
To Bank Charges (debited twice)
Total
108
Rs.
150
1,000
500
5
9,655
By Bank Charges
50
By Debtors (Dishonoured cheques)
1,000
By Creditors
1,500
By Balance c/fd
5,055
Total
9,655

(After making adjustments in the cash book)
5,055
Add :
2,000

Sub-Total
7,055
1,850
b. Wrong debits given by bank for cheque
50
1,900
Sub-Total
5,155
Illustration
From the following particulars, prepare the bank reconciliation statement for Mr. S.Sarkar as
on 31st December, 1985 before and after making necessary adjustments in the cash book.
a.
Bank Balance as per cash book Rs. 610 (Credit).
b.
Cheques issued but not presented Rs. 3,000.
c.
Cheques deposited but not cleared Rs. 2,500.
d.
A cheque drawn for Rs. 100 has been incorrectly entered as Rs. 10 in the cash book.
e.
A debtor directly deposited into Sarkars bank account but not recorded in the cash
book Rs. 1,000.
f.
Payment side of the cash book was undercast by Rs. 500.
g.
A cheque for Rs. 5,000 drawn by Mr. Banerjee has been charged to Sarkars account in error.
h.
Bank paid a Bill Payable for Rs. 1,450 but it was recorded in the cash book as Rs. 1,540.
i.
The receipt column of cash book was overcast by Rs. 1,000.
j.
Discount allowed Rs. 410 has been entered through mistake with the cheque in the bank
column of the cash book.
k.
Pursuant to instructions dated 30th December, 1985, asking the banker to transfer
Rs. 10,000 to fixed deposit account and entry for this was made in the cash book but the
bank acted in January 1986.
l.
The bank debited the account with Rs. 500 being the amount of cheque received from a
customer and returned unpaid but not entered in the cash book.
m.
Cheques amounting to Rs. 300 though actually banked were not entered in the cash book.
109
Solution
Bank Reconciliation Statement as on 31st December, 1985
(Before making adjustments in the cash book)
Bank Balance as per Cash Book (Overdraft)
Add :
610
2,500
b. Cheque for Rs. 100, entered as Rs. 10
90
c. Payment side of cash book undercast
500
d. Wrong debit in pass book for Mr. Banerjees Cheque
5,000
e. Receipt column of cash book overcast
1,000
f.
Discount allowed treated as receipt of cheque

in the cash book
410
g. Cheque dishonoured
500
Sub-Total
Less : a. Cheques issued but not presented

b. Amount deposited by debtor in bank account
10,610
3,000
1,000
c. Bill Paid for Rs. 1,450 entered as Rs. 1,540
90
d. Cheques deposited but not entered in cash book

c. Transfer to fixed deposit
10,000
300
10,000
Bank Balance as per Bank Statement
14,390
3,780

Particulars
To Debtor
To Creditor
To Fixed Deposit Account
To Debtors
Rs.
1,000
90
10,000
300
Particulars
Rs.
By Balance b/fd
610
By Creditor
By Payment side undercast
By Receipt side overcast
110
11,390
500
1,000
By Discount
410
By Debtors
500
By Balance c/fd
Total
90
Total
8,280
11,390
Bank Reconciliation Statement as on 31st December, 1985

(After making adjustments in the cash book)
8,280
Add :
3,000

Sub-Total
11,280
2,500
b. Wrong debits given by bank for cheque
5,000
Sub-Total
7,500
3780
Illustration
Following are the cash book and pass book of Mr. X for the month of April, 2002.
Date
Particulars
01.4.02
To balance b/fd
04.4.02
To Sales A/c
08.4.02
Rs.
12,500
Date
Particulars
Rs.
01.4.02 By Salaries (C.No. 183)
4,000
8,000
06.4.02 By Purchases (C.No. 184)
3,200
To P A/c
1,500
11.4.02
6,000
13.4.02
To M A/c
3,400
15.4.02 By Omprakash (C.No. 186) 1,000
18.4.02
To Kamal A/c
4,600
19.4.02 By Drawings (C.No. 187)
21.4.02
To Furniture A/c
1,200
23.4.02 By K A/c (C.No. 188)
2,000
25.4.02
To Sales A/c
3,800
27.4.02 By S A/c (C.No. 189)
1,000
30.4.02
To F A/c
3,000
30.4.02 By Printing (C.No. 190)
By Machinery (C.No. 185)
30.4.02 By Balance c/fd

38,000
800
500
19,500
38,000
111
Pass Book
Date
Particulars
C.No.
01.4.02
By Balance b/fd
02.4.02
To Cheque
06.4.02
By Cheque
06.4.02
To Cheque
10.4.02
By Cheque
16.4.02
By Cheque
17.4.02
To Cheque
20.4.02
By Cheque
24.4.02
By Cheque
28.4.02
To Cheque
185
28.4.02
To Cheque
189
30.4.02
By Interest
30.4.02
By Deposit (K.Sen)
30.4.02
To Charges
Withdrawals
183
Deposits
Dr/Cr.
Balance
Cr.
12,500
Cr.
8,500
Cr.
16,500
Cr.
13,300
1,500
Cr.
14,800
3,400
Cr.
18,200
Cr.
17,400
4,600
Cr.
22,000
3,800
Cr.
25,800
6,000
Cr.
19,800
1,000
Cr.
18,800
100
Cr.
18,900
3,000
Cr.
21,900
Cr.
21,890
4,000
8,000
184
187
3,200
800
10
You are required to prepare a Bank Reconciliation Statement as on 30th April 2002.
Solution
Bank Reconciliation Statement as on 30th April, 2002
Bank Balance as per Cash Book
Add :
19,500

(Rs. 1,000 + Rs. 2,000 + Rs. 500)
3,500
b. Deposited by K.Sen
3,000
c. Interest credited by bank, not in cash book
100
6,600
Sub-Total
26,100

(Rs. 1,200 + Rs. 3,000)
4,200
b. Bank Charges debited by bank
10
Sub-Total
112
4,210
21,890
Illustration
Fun Fare Limited have a current account with National Bank Limited. The following is the
extract from the Banks books of account for the last week of June, 1988.
Particulars
C.No.
Withdrawals
Deposits
Dr/Cr.
Balance
Cr.
21,000
Cr.
17,000
Cr.
22,000
Cr.
14,800
Cr.
22,300
Balance b/fd
Gopal Brothers
212
4,000
Madhu Industries
N Traders
5,000
213
7,200
Ram Gopal Sons
7,500
Gopal Brothers
215
4,100
Cr.
18,200
Ourselves
216
2,400
Cr.
15,800
Cr.
16,300
10
Cr.
16,290
900
Cr.
15,390
Dividend Warrants
500
Incidental Charges
Interest on Loan
Lal Chand
217
1,000
14,390
It is understood that
a.
Cheque no. 214 drawn in favour of T.W.Traders for Rs. 2,100 was not yet presented to the bank.
b.
Advice regarding the incidental charges, interest on loan and dividend warrants reached
Fun Fare Limited only in July.
c.
Cheque favouring Lal Chand was towards rent for the month of June.
From the above data you are required to prepare a cash book (bank column only) of Fun Fare
Limited and a bank reconciliation statement in their books at the end of the month.
Solution :
Date
Particulars
30.6.88
To Balance b/fd
Rs.
21,000
Date
Particulars
30.6.88 By Gopal Brothers
Rs.
4,000
To Madhu Industries
5,000
By N Traders
7,200
To Ram Gopal
7,500
By T W Traders
2,100
By Gopal Brothers
4,100
By Cash
2,400
By Rent
1,000
By Balance c/fd
33,500
12,700
33,500
113
Bank Reconciliation Statement as on 30th April, 2002

Bank Balance as per Cash Book
Add :
12,700
2,100
b. Dividend collected by bank, not in cash book
500
2,600
Sub-Total
Less : a. Incidental charges debited by bank
15,300
10
b. Interest on Loan debited by bank
900
Sub-Total
910
14,390
QUESTIONS
114
1.
What do you mean by Bank Reconciliation Statement ? What are the reasons for
difference between the balance shown by cash book and the one shown by the pass
book?
2.
What are the different causes of discrepancy between bank balance as per cash book
and pass book ?
3.
What is Bank Reconciliation Statement ? Why is it prepared ?
PROBLEMS
Q. 1
The Bank account of Mukesh was balanced on 31st March, 1992. It showed an overdraft of
Rs. 5,000. The Bank Statement of Mukesh showed a credit balance of Rs. 76,750. Prepare a
Bank reconciliation statement taking the following information into account
a.
Cheques issued but not presented for payment till 31st March, 1992 Rs. 12,000.
b.
Cheques deposited but not collected by bank till 31st March, 1992 Rs. 20,000.
c.
Interest on term loan Rs. 10,000 debited by bank on 31st March, 1992 but not accounted
in Mukeshs books.
d.
Bank charges Rs. 250 was debited by bank but accounted in the books of Mukesh on
4th April, 1992.
e.
An amount of Rs. 1,00,000 representing collection of Mukeshs cheques was wrongly

credited to the personal account of Mukesh by the bank in their bank statement.
Q. 2
From the following particulars, prepare a Bank Reconciliation Statement as on 31st December,
1993.
a.
On 31st December, 1993, the cash book of a firm showed a bank balance of Rs. 6,000
(Debit Balance).
b.
Cheques had been issued for Rs. 5,000, out of which cheque worth Rs. 4,000 only were
presented for payment.
c.
Cheques worth Rs. 1,400 were deposited in the bank on 28th December, 1993 but had
not been credited by the bank. In addition to this, one cheques for Rs. 500 was entered
in the cash book on 30th December, 1993 but was banked on 3rd January, 1994.
d.
A cheque from Susan for Rs. 400 was deposited in the bank on 26th December, 1993
but was dishonoured and the advice was received on 3rd January, 1994.
e.
Passbook showed bank charges of Rs. 20 debited by the bank.
f.
One of the debtors deposited a sum of Rs. 500 in the bank account of the firm on 20th
December, 1993 but the intimation in this respect was received from the bank on 2nd
January, 1994.
g.
Bank Passbook showed a credit balance of Rs. 5,180 on 31st December, 1993.
115
Q. 3
On 31st May, 1994, the cash book of ABC Ltd. showed a bank overdraft of Rs. 1,234. On an
examination of the cash book and bank pass book, the following information was gathered
a.
Two cheques received from P and Q for Rs. 234 and Rs. 456 respectively were deposited
with the bank on 30th May, 1994, but they were cleared only on 1st June 1994.
b.
A cheque for Rs. 345 issued on 26th May, 1994 was presented to the bank for payment
on 3rd June, 1994.
c.
A cheque for Rs. 567 deposited by a customer in the companys account with bank
directly on 25th May, 1994.
d.
Rs. 5,678 being proceeds of a bill collected on 30th May, 1994 did not appear in the cash book.
e.
A bill payable for Rs. 5,789 was duly paid off on 31st May, 1994 according to the instructions
of the company, entry of which was made in the cash book on 1st June, 1994.
f.
Interest on overdraft Rs. 111 appears in the pass book.
Q. 4
On 31st January, 1988, my cash book showed a bank overdraft of Rs. 12,500. On comparing
it with the pass book, following differences were located
a.
Cash and cheques amounting Rs. 1,340 were sent to bank on 27th January, but cheques
worth Rs. 230 were credited on 2nd February and one cheque for Rs. 45 was returned by
them as dishonoured on 4th February.
b.
During the month of January, I issued cheques worth Rs. 1,760 to my creditors. Out of
these, cheques worth Rs. 1,370 were presented for payment on 5th February.
c.
According to my standing orders, the bankers have paid during the month of January the
following
Life insurance premium Rs. 170
Driving license fee Rs.40
d.
My bankers have collected Rs. 150 as dividend on the shares.
e.
My bankers have given me wrong credit for Rs. 150.
f.
A bill receivable for Rs. 100 discounted with the bank in December, 1987 has been
dishonoured on 31st January, 1988.
g.
Interest charged by the bank Rs. 125.
Prepare a bank reconciliation statement on 31st January, 1988.
116
Q. 5
From the following particulars, find out adjusted bank balance as per cash book and prepare
thereafter bank reconciliation statement as on 31st December, 1995 of Raja Brothers
Particulars
Bank Overdraft as per Cash Book
Rs.
80,000
Cheques deposited as per bank statement but not entered in cash book
Cheques recorded for collection but not sent to the bank
3,000
10,000
Credit side of bank column cast short
1,000
Bank charges recorded twice in the cash book
100
Customers cheques returned as per bank statement only
4,000
Cheques issued but dishonoured on technical grounds
3,000
Bills collected by bank directly
20,000
Cheques received entered twice in cash book
5,000
Q. 6
The cash book of a firm showed an overdraft of Rs. 30,000 on 31st March, 1999. A comparison
of the entries in cash book and pass book revealed that
a.
On 22nd March, 1999, cheques totaling Rs. 6,000 were sent to bankers for collection. Out
of these, a cheques for Rs. 1,000 was wrongly recorded on the credit side of the cash book
and cheques amounting to Rs. 300 could not be collected by bank before 1st April, 1999.
b.
A cheque for Rs. 4,000 was issued to a supplier on 28th March, 1999. The cheque was
presented to bank on 4th April, 1999.
c.
There were debits of Rs. 2,600 in the pass book for interest on overdraft and bank
charges, but the same had not been recorded in the cash book.
d.
A cheque for Rs. 1,000 was issued to a creditor on 27th March 1999, but by mistake the
same was not recorded in the cash book. The cheque was however duly encashed on
31st March, 1999.
e.
As per standing instructions, the banker collected dividend of Rs. 500 on behalf of the
firm and credited the same to its account by 31st March, 1999. The fact was however
intimated to the firm on 3rd April, 1999.
You are required to prepare a bank reconciliation statement as on 31st March, 1999.
117
Q. 7
On 31st March, 1998, Mehtas Pass Book showed a debit balance of Rs. 6,350. From the
following information, prepare a Bank Reconciliation Statement as on that date
1.
Out of total cheques of Rs. 6,000 deposited into the bank in March. 1998, one cheque of
Rs. 500 was collected on 28th March, 1998 and another cheque of Rs. 1,000 was
collected on 3rd April, 1998.
2.
The bank had paid a premium of Rs. 300 on 17th March for which there was no entry
made in the cash book.
3.
The total of debit side bank column of cash book was undercast by Rs. 100.
4.
Amount withdrawn from the bank on 26th March Rs. 200 was not recorded in the cash
book at all.
5.
During March, cheques issued amounted to Rs. 2,000 of which cheques for Rs. 1,500
were presented to the bank on 2nd April 1998.
Q. 8
D. Diwakars Pass Book shows a balance of Rs. 5000 (Credit) on 30th June, 1998. His cash
book shows a different balance. On an examination, it is found that
a.
No record has been made in the cash book for dishonour of a cheque for Rs. 100.
b.
Cash and cheques amounting to Rs. 700 were paid into the bank on 29th June, 1998 and
the same had not been entered in the pass book.
c.
Bank charges of Rs. 15 have not been entered in the cash book.
d.
Cheques amounting to Rs. 1,800 issued by P. Prabhakar and paid into the bank on 28th
June, 1998 had not been credited.
Prepare a bank reconciliation statement as on 30th June, 1998.

Q. 9
On 30th September 1998, cash book of a firm showed a bank balance of Rs. 7,500. From the
following information, prepare a bank reconciliation statement showing the balance as per
pass book
118
a.
Cheques amounting to Rs. 1,200 were paid on 28th September, 1998 had not been
credited by the bank. One cheque for Rs. 375 was entered in the cash book on 28th
September, 1998 but was banked on 3rd October, 1998.
b.
Cheques issued for Rs. 900 had not yet been presented for payment at the bank.
c.
A cheque for Rs. 200 paid on 26th September, 1998 was dishonoured but the advice was
received only on 3rd October, 1998.
d.
Bank charges of Rs. 15 were debited in the pass book by the bank.
e.
There was an entry in the pass book for the receipt of Rs. 600 collected by the bank as
interest.
Q. 10
From the following particulars, ascertain the balance by means of a statement that would
appear in the pass book of Mr. S.Gavaskar as on 31st December 1998.
a.
Overdraft as per Cash Book Rs. 4,558.
b.
Interest on overdraft for six months ending 31st December, 1998 Rs. 120.
c.
Bank charges debited in the pass book Rs. 24.
d.
Cheques drawn but not cashed by the customers prior to 31st December, 1998 Rs. 1,326.
e.
Cheques paid into the bank but not cleared before 31st December, 1998 Rs. 2,412.
f.
A Bill Receivable originally discounted with the bank in November 1998 is dishonoured
Rs. 800.
Q. 11
From the following particulars, ascertain the balance that would appear in the cash book of
Mr. M. Ranganathan as on 31st December, 1998
a.
Overdraft balance as per Pass Book Rs. 24,240.
b.
Cheques amounting to Rs. 8,200 were paid into the bank on 28th December, 1998 out of
which only Rs. 600 was credited by the bank in the pass book till 31st December, 1998.
c.
Cheques for Rs. 5,400 were issued on 28th December, 1998 out of which only one
cheque for Rs. 800 was presented for payment.
d.
There is a debit of Rs. 200 for interest and Rs. 50 for bank charges in the pass book
which have not been entered in the cash book.
e.
Rs. 400 debited to bank account in the cash book has been omitted to be banked.
f.
There was a wrong debit of Rs. 600 in the pass book.
119
Q. 12
On 30th June, 1990, the pass book of Sunil & Co. showed a balance of Rs. 9,800 as cash at
bank
a.
Prior to that date, they had issued cheques amounting to Rs. 3,500, of which, cheques
amounting to Rs. 1,900 have so far been presented for payment.
b.
Out of the cheques for Rs. 2,000 paid by him into the bank before that date, only cheques
for Rs. 1,200 were credited in the pass book.
c.
He had also received a cheque for Rs. 680 which although entered in the cash book had
been omitted to be paid into bank.
d.
The bank had collected dividend directly and credited them.
Q. 13
From the following particulars, prepare a Bank Reconciliation Statement as on 28th February,
1989. Thiru Pandiyan had an overdraft balance of Rs. 80,500 as shown by the bank columns
of the cash book. Cheques amounting to Rs. 10,000 had been paid into the bank on 24th
February, 1989 but of these only Rs. 7,500 were credited in the pass book. He had issued
cheques amounting to Rs. 25,000, of which Rs. 20,000 worth only seem to have been presented.
The bank has debited in the pass book Rs. 750 for interest. A cheque for Rs. 600 which was
debited in the bank column in the cash book has been omitted to have been presented. An
entry appears in the pass book for Rs. 3,000 for a direct deposit by a customer of Thiru
Pandiyan.
Q. 14
On 31st March 1991 the cash book of Mr. X showed a bank balance of Rs. 14,850. While
verifying with the pass book, the following facts were noted
120
a.
Cheques sent in for collection before 31st March, 1991 and not credited by bank amounted
to Rs. 845.
b.
Cheques issued before 31st March, 1991 but not presented for payment amounted to Rs. 885.
c.
The banker has debited a sum of Rs. 100 towards the bank charges and credited Rs. 250
for interest received and Rs. 1,000 for dividend collected.
d.
The banker has given a wrong credit for Rs. 250.
e.
Mr. Y has paid into the bank a sum of Rs. 300 on 28th March, 1991 which has not been
entered in the cash book.
f.
A cheque for Rs. 200 sent for collection returned dishonoured has not been entered in
the cash book.
Q. 15
Find out the balance as per pass book from the following particulars
a.
Bank overdraft as per cash book on 30th April, 1992 was Rs. 2,000.
b.
Cheque issued but not presented for payment Rs. 1,350.
c.
Cheques deposited but not yet collected by the banker Rs. 500.
d.
Bank charges Rs. 80 debited by the bank not yet entered in the cash book.
e.
Interest on investments collected by the bankers and credited in the pass book amounted
to Rs. 905.
Q. 16
From the following particulars, ascertain the balance that would appear in the cash book of B
as on 31st December, 1998, before and after making necessary adjustments
a.
Overdraft as per pass book as on 31st December 1998 Rs. 13,880.
b.
Interest on overdraft for six months ending 31st December 1998 not yet entered in the
cash book Rs. 240.
c.
Bank charges for the above period not yet entered in the cash book Rs. 60.
d.
Cheques drawn but not encashed by customers before 31st December, 1998 Rs. 3,300.
e.
Cheques paid into the bank but not cleared before 31st December, 1998 Rs. 4,340.
f.
A Bill Receivable, discounted with the bank in November, dishonoured on 31st December,
1998 Rs. 1,000.
Q. 17
From the following particulars taken on 31st December, 1989, you are required to prepare a
bank reconciliation statement to reconcile the bank balance shown in the cash book with that
shown in the pass book
a.
Balance as per pass book on 31st December, 1989 Rs. 1,027 (Credit).
b.
Four cheques drawn on 31st December but not cleared till January Rs. 1,144.
c.
Interest on overdraft not entered in the cash book Rs. 51.
d.
Three cheques received on 30th December, 1989 and entered in the bank column of
cash book but not lodged in bank for collection till 3rd January, Rs. 5,280.
e.
Cost of cheque book Rs. 5 entered twice erroneously in cash book in November.
f.
A Bill Receivable for Rs. 250 on 29th December, 1989 was passed to the bank for
collection on 28th December, 1989 and was entered in the cash book forthwith, whereas
the proceeds were credited in the pass book only in January following.
121
g.
Chamber of Commerce subscription Rs. 10 paid by bank on 1st December, 1989 had
not been entered in the cash book.
h.
Bank Charges of Rs. 5 had been debited in the pass book twice erroneously.
Q. 18
On 30th June, 1981, the pass book of M/s Thin and Short showed a balance of Rs. 2,000 at
the bank. They had sent cheques amounting to Rs. 10,000 to the bank before 30th June, 1981
but it appears from the pass book that cheques worth Rs. 9,000 had been credited before that
date. Similarly, out of the cheques for Rs. 5,000 issued during the month of June, cheques for
Rs. 4,000 were presented and paid in July. The pass book showed the following payments
a.
Rs. 320 as premium according to standing instructions.
b.
Rs. 2,000 against a promissory note as per the instructions.
The pass book showed that the bank had collected Rs. 1,800 as interest on Government
Securities. The bank had charged as interest Rs. 50 and incidental expenses Rs. 20. There
was no entry in the cash book for the payment of interest etc. A bill sent for collection was
returned dishonoured on 29th June amounting to Rs. 600.
Prepare the Bank Reconciliation Statement as on 30th June, 1981.
Q. 19
From the following particulars, prepare a bank reconciliation statement showing the balance
as per pass book on 31st March, 1989.
122
a.
Cheques for Rs. 7,900 was paid into bank in March, 1989 but were credited only in April,
1989.
b.
Cheques for Rs. 11,000 were issued in March, 1989 but were cashed in April, 1989 only.
c.
A cheque for Rs. 1,000 which was received from a customer was entered in the bank
column of the cash book in March, 1989 but the same was paid into the bank in April,
1989 only.
d.
The pass book shows a credit of Rs. 2,500 for interest and a debit of Rs. 500 for bank
charges.
e.
The bank balance as per cash book was Rs. 1,80,000 on 31st March, 1989.
Q. 20
From the following particulars, prepare a bank reconciliation statement as at 31st December, 1991.
a.
As on 31st December, 1991, bank overdraft as per cash book Rs. 2,49,900.
b.
Interest debited in the bank pass book only Rs. 27,870.
c.
Cheques issued but not presented for payment Rs. 66,000.
d.
Draft deposited in the bank but not yet credited in the pass book Rs. 13,500.
e.
Dividend collected by the bank Rs. 42,500 has not yet been entered in the cash book.
f.
A direct payment into the bank by a customer Rs. 16,000 has not been recorded in the
cash book.
g.
Bank column on the debit side of the cash book has been undercast by Rs. 3,500.
Q. 21
From the following particulars, prepare a bank reconciliation statement showing the balance
as per cash book as on 31st December, 1997.
The following cheques were paid into the bank in December 1997 but were credited by the
bank in January, 1998.
Premnath Rs. 350
Shaym Lal Rs. 250
Ram Lal Rs. 200
The following cheques were issued by the firm in December, 1997 but were presented for
payment in January, 1998.
Suresh Rs. 400
Ramesh Rs. 450
A cheque for Rs. 100 which was received from a customer was entered in the bank column of
cash book in December, 1997 but was omitted to be banked in the month of December, 1997.
The pass book shows a credit of Rs. 100 for interest and a debit of Rs. 20 for bank charges.
The bank balance as per pass book was Rs. 6,200 as on 31st December, 1997.
Q. 22
According to the cash book of Gopi, there was a balance of Rs. 44,500 standing to his credit
on 30th June, 1996. On investigation you find that
1.
Cheques amounting to Rs. 60,000 issued to creditors have not been presented for payment
till that date.
123
2.
Cheques paid into bank amounting to Rs. 1,05,000 out of which cheques amounting to
Rs. 55,000 only collected by the bank up to 30th June, 1996.
3.
A dividend of Rs. 4,000 and rent amounting to Rs. 6,000 received by the bank and
entered in the pass book but not recorded in the cash book.
4.
Insurance premium (up to 31st December, 1996) paid by the bank Rs. 2,700 not entered
in the cash book.
5.
The payment side of the cash book had been undercast by Rs. 50.
6.
Bank charges Rs. 50 shown in the pass book had not been entered in the cash book.
7.
A bill payable for Rs. 2,000 has been paid by the bank but is not entered in the cash
book and bill receivable for Rs. 6,000 has been discounted with the bank at a cost of
Rs. 100 which has also not been recorded in the cash book.
You are required

a.
to make appropriate adjustments in the cash book.
b.
To prepare a statement reconciling it with the bank pass book.
Q. 23
From the following extracts of the cash book (bank column) and bank pass book of Mr.X,
prepare the bank reconciliation statement for the month ending on 31st March, 1997.
Date
Particulars
01.3.97
To Balance b/fd
03.3.97
To D
05.3.97
Date
Particulars
Rs.
02.3.97
By Drawings
500
750
03.03.97
By K
700
To A
250
08.3.97
By Rent
450
16.3.97
To M
800
12.3.97
By P
650
21.3.97
To N
2,500
21.3.97
By S
330
24.3.97
To R
1,700
24.3.97
By H
900
28.3.97
By Wages & Salaries
770
31.3.97
By Balance c/fd
2,700
Total
7,000
Total
124
Rs.
1,000
7,000
Extracts of Pass Book of Mr. X

In the books of Bank of Baroda, Pune
Date
Particulars
01.4.97
Balance b/fd
02.4.97
02.4.97
04.4.97
04.4.97
Pal
05.4.97
07.4.97
09.4.97
11.4.97
Sen
11.4.97
Bose
Withdrawals
Deposits
Dr/Cr
Balance
Cr
1,280
Cr
630
Cr.
3,130
Cr.
2,780
500
Cr.
3,280
800
Cr.
4,080
330
Cr.
3,750
900
Cr.
2,850
Cr.
3,150
Cr.
3,620
650
2,500
350
300
470
Prepare a Bank Reconciliation Statement as on 31st March, 1997.

Q. 24
On 31st December, 1982, the bank column of the cash book of P shows a debit balance of
Rs. 922. On examination of cash book and statement, you find that
a.
Cheques amounting to Rs. 1,260 issued before 31st December and entered in the cash
book were not presented for payment till that date.
b.
Cheques amounting to Rs. 500 entered in the cash book as sent to the bank on
31st December were entered in the bank statement after that date.
c.
A cheque from a debtor for Rs. 146 had been dishonoured prior to 31st December but no
record appeared in the cash book.
d.
A dividend warrant for Rs. 76 was paid direct to the bank and nothing appeared in the
cash book.
e.
Bank interest and charges amounting to Rs. 84 were not entered in the cash book but
appeared in the bank statement.
f.
There was no entry in the cash book for a club membership subscrption Rs. 20 paid by
bankers order in November, 1982.
g.
Bank charges for a cheque book received by P Rs. 2 were entered in the cash book
twice.
125
h.
A cheque for Rs. 54 drawn by Q had been charged to Ps account in error.
Make appropriate adjustment in the cash book to bring down the correct balance and prepare
a bank reconciliation statement reconciling the corrected cash book balance with the balance
as per bank statement.
Q. 25
When Sweetex Limited received its bank statement for the period ended 30th June, 1984, this
did not agree with the balance shown in the cash book of Rs. 2,972 in the companys favour.
An examination of the cash book and bank statement disclosed the following
126
a.
A deposit of Rs. 492 paid on 29th June 1984 had not been collected by the bank until
1st July, 1984.
b.
Bank charges amounting to Rs. 17 had not been entered in the cash book.
c.
A debit of Rs. 42 appeared in the bank statement for an unpaid cheque which had been
returned marked out of date. The cheque had been re-dated by the customer of Sweetex
Limited and paid into the bank again on 3rd July, 1984.
d.
A standing order for payment of an annual subscription amounting to Rs. 10 had not
been entered in the cash book.
e.
On 25th June, 1984, managing director had given the cashier a cheque for Rs. 100 to
pay into his personal account at the bank. The cashier had paid the same into companys
account by mistake.
f.
On 27th June, two customers of Sweetex Limited had paid direct to the companys bank
account Rs. 499 and Rs. 157 respectively for the payment of goods supplied. The advices
were not received by the company until 1st July and were not entered in the cash book
until that date.
g.
On 30th March, 1984, the company had entered into a hire purchase agreement to pay
by bankers order a sum of Rs. 26 on the 10th day of each month, commencing April. No
entries had been made in the cash book.
h.
A cheque for Rs. 364 received from Mr. B and paid into the bank had been entered twice
in the cash book.
i.
Cheques issued amounting to Rs. 4,672 had not been presented to the bank for payment
until 30th June, 1984.
j.
A customer of the company who received a cash discount 2.5% on his account of
Rs. 200 paid the company a cheque on 10th June. The cashier in error entered the gross
amount in the bank column of the cash book.
After making the adjustments required by the foregoing, the bank statement reconciled with
the balance in the cash book.
You are required
1.
to show the necessary adjustments in the cash book of Sweetex Limited bringing down
the correct balance on 30th June, 1984.
2.
to prepare a Bank Reconciliation Statement
127
NOTES
128
Chapter 5
RECTIFICATION OF ERRORS
The errors in accounting can be classified into the following main groups
a.
Errors of Omission These errors refer to a situation where a transaction is totally

omitted to be recorded in the subsidiary book or partially omitted while posting from
subsidiary books to the ledger.
b.
Errors of Commission These errors refer to wrong posting or totalling errors,

calculation errors or errors in carrying forward etc. Following are the examples of errors
of commission
c.
d.
Posting of wrong amounts
Posting to wrong side of account
Posting to wrong account
Wrong totalling of subsidiary books or ledger accounts
Errors while carrying forward figures from one page to another page
Errors of Principle These errors refer to wrong classification of income or expenditure.

Following are the examples of errors of principle
l
Purchases of fixed assets recorded in the Purchases Register
Revenue expenditure treated as capital expenditure
Capital receipt treated as revenue income
Revenue receipt treated as capital receipt
Compensating Error These errors refer to a situation where excess or less debits in
one or more accounts are compensated by equal amount of excess or less credits in
one or more accounts. Due to these errors arithmetical accuracy of the Trial Balance
does not get affected.
129
EFFECT OF ERRORS ON TRIAL BALANCE

Tallying of Trial Balance is the primary indication about the arithmetical accuracy of the books
of account. However, it cannot be the conclusive evidence of the total accuracy of the books of
accounts maintained. This is due to the fact that certain errors as stated above do not affect
the trial balance. As such, locating the errors requires a lot of skills, particularly when they do
not affect the agreement of trial balance.
Errors affecting Trial Balance
Following errors may affect the agreement of Trial Balance
a.
Wrong totalling of subsidiary books If the total of any subsidiary books is taken
wrongly but the posting to the individual accounts is made correctly, it will affect the
agreement of trial balance. Eg. Total of Purchase Register for the month of March is
taken as Rs. 1,50,000 instead of Rs. 1,55,000. Posting to the individual accounts of
suppliers total to the correct amount of Rs. 1,55,000, but the Purchases Account is
debited by Rs. 1,50,000, the trial balance will not agree.
b.
Posting on the wrong side of an account If a transaction is posted on the wrong

side of the account, the trial balance will not agree. Eg. A payment of Rs. 10,000 made
to M/s. Pam Industries is posted on the credit side of M/s. Pam Industries Account, the
trial balance will not agree.
c.
Omission of posting an amount in the ledger If an amount is entered in the journal

or subsidiary book but not posted in the ledger, the trial balance will not agree. Eg. A
cash payment of Rs. 1,500 for the conveyance expenses has been entered in the cash
book but is not debited to Conveyance Account, the trial balance will not agree.
d.
Posting of wrong amount If an amount is wrongly posted to an account, the trial

balance will not agree. Eg. A cash payment of Rs. 1,500 for the conveyance expenses
has been correctly entered in the cash book, but while posting the same to the Conveyance
Account, it is posted as Rs. 150, the trial balance will not agree.
e.
Error in balancing If an error has been committed while calculating the closing balance
of cash book or a ledger account, the trial balance will not agree.
Errors not affecting the Trial Balance

Following types of errors may not affect the agreement of Trial Balance.
a.
130
Errors of Principle If the revenue expenditure is treated as capital expenditure or if

revenue receipt is treated as capital receipt or if capital expenditure is treated as revenue
expenditure or if capital receipt is treated as revenue receipt, it will not affect the agreement
of trial balance. Eg. An amount of Rs. 10,000 paid for maintenance of machinery. Instead
of posting this amount to Machinery Maintenance Account, it is debited to Machinery
Account, the trial balance will still agree but it will not show a true and fair view.
b.
Errors of Omission If a transaction is totally omitted while making the entries in the
books of accounts, it will not affect the agreement of trial balance. Eg. A bill for the
purchase of material worth Rs. 15,000 has been received, but it is not entered in the
Purchase Register at all, the trial balance will still agree but it will not show a true and fair
view.
c.
Errors of Commission If an amount is posted to the correct side of a wrong account,

it will not affect the agreement of trial balance. Eg. A payment is Rs. 25,000 made to
Mr. Salim is debited to the account of Mr. Sham, the trial balance will still agree but it will
not show a true and fair view.
d.
Recording of wrong amount in the books of prime entry or subsidiary books If

a transaction is wrongly entered in the book of prime entry or the subsidiary book and
then correctly posted to the correct account, it will not affect the agreement of trial
balance. Eg. Stationary worth Rs. 4,500 has been purchased but it is entered as Rs.
4,700 in the cash book, the trial balance will still agree but it will not show a true and fair
view.
e.
Compensating Errors If one type of error is compensated by the error of the opposite
nature, it will not affect the agreement of trial balance. Eg. While balancing the traveling
expenses account, the closing debit balance is taken as Rs. 1,40,000 instead of
Rs. 1,50,000. Similarly, while balancing the sales account, the closing credit balance is
taken as Rs. 28,90,000 instead of Rs. 29,00,000. The trial balance will still agree but it
will not show a true and fair view.
Steps in locating the errors

If the errors result into the disagreement of trial balance, following steps should be taken to
locate the errors.
a.
Total of all the subsidiary books and cash book should be checked carefully. Similarly,
the total of trial balance should be checked carefully.
b.
It should be ensured that all the opening balances have been correctly brought forward in
the current years books of account.
c.
It should be ensured that all the ledger accounts have been properly balanced and the
balances of all the ledger accounts have been reflected in the Trial Balance.
d.
If an amount of Rs. 24,000 is debited to a certain account instead of crediting the same
to the same account, the difference between the debit side and credit side of trial balance
131
will be Rs. 48,000. As such, the difference in trial balance should be halved to locate
such errors.
e.
If the difference in the trial balance is divisible by 9 without any reminder, it may indicate
the transposition or transplacement of the amounts. Eg. If the cash payment of Rs. 176
is posted as Rs. 167, the difference in the trial balance will be divisible by 9.
f.
The trial balance of the current year can be compared with the trial balance of the previous
year to locate certain highlighting error.
How to rectify the errors

The errors should be rectified by any one of the following methods
I.
In some cases, if the trial balance does not agree but the books have to be closed, the
difference is placed to a Suspense Account and the trial balance is tallied. If the credit
side of the trial balance is heavy by Rs. 50,000 and same amount is placed on the debit
side of Suspense Account. Subsequently, attempts are made to locate the errors and
the rectification entries are routed through the Suspense Account. After all the errors
have been located, the balance in Suspense Account will become zero. It should be
remembered that the Suspense Account is operated till the errors are located and finally
the balance in Suspense Account has to become zero. Further, only the errors affecting
the agreement of trial balance are routed through the Suspense Account.
Illustration
A merchant while balancing his books of account finds that, the trial balance shows excess
credit of Rs. 1,700. Being required to prepare the final accounts, he places the difference to a
newly opened Suspense Account which he carries forward. In the next accounting year, the
following errors are discovered
a.
Goods bought from Narayan amounting to Rs. 5,000 had been posted to the credit of
Narayan as Rs. 5,500.
b.
An item of Rs. 1,000 entered in the sales returns book was posted to the debit of Pandey
who had returned the goods.
c.
Sundry items of furniture sold for Rs. 26,000 had been entered in the sales book. Ignore
depreciation and profit or loss on the sale.
d.
Discount amounting to Rs. 200 from a creditor had been duly entered in the creditors
account, but not posted to discount account.
Draft journal entries necessary for rectifying the abovementioned errors. Prepare the Suspense
Account and show the ultimate effect of the errors on the last years profit by preparing the
Profit and Loss Adjustment Account.
132
Solution
a.
Goods bought from Narayan had been posted to the credit of Narayan Account by
Rs. 5,500 instead of Rs. 5,000. As such, Narayan Account has been credited more by
Rs. 500. As such, this excess credit needs to be reversed by passing following entry
Narayan A/c. Dr. 500
To, Suspense A/c. 500
b.
Goods supplied to Pandey worth Rs. 1,000 should have appeared on the debit side of
Pandeys account. Instead of that the entry has been made on the credit side of Pandeys
account. This excess credit needs to be reversed by passing the following entry
To Suspense A/c. Dr. 2,000
Pandey A/c. 2,000
c.
As the amount of furniture sold has been entered in the sales book, sales account has
been wrongly credited. This wrong credit needs to be reversed by debiting sales account.
The journal entry to be passed is
Sales A/c. Dr. 26,000
To Furniture A/c. 26,000
d.
Discount received from the creditor has been entered in the creditors account but discount
account has not been credited. As such, the error will be rectified by passing the following
entry
Suspense A/c. Dr. 200
To Discount Received A/c. 200
Suspense Account
Date
1
1
Particulars
To Balance b/fd
To Discount Recd. A/c.
To Balance c/fd
Folio
Rs.
1,700
200
600
2,500
II.
Date
Particulars
1
1
By Narayan A/c.
By Pandey A/c.
Folio
Rs.
500
2,000
2,500
The errors which affect two accounts and which do not affect the agreement of trial
balance may be rectified by passing the rectification entries. The basic principle for
rectifying the errors by this means suggests the following steps to be taken
a.
What is the wrong entry passed ?
133
b.
What should be the correct entry to be passed ?
c.
Nullify the wrong effect by reversing the same and reinstate the correct by passing
the rectification entry.
Illustration
Pass necessary journal entries to rectify the following errors
134
a.
An amount of Rs. 200 withdrawn by the proprietor for his personal use has been debited
to trade expenses account.
b.
A purchase of goods from Nathan amounting to Rs. 300 has been wrongly entered
through the sales book.
c.
A credit sale of Rs. 100 to Santhanam has been wrongly passed through the purchase
book.
d.
Rs. 150 received from Malhotra have been credited to Mehrotra.
e.
Rs. 375 paid on account of salary to the cashier Dhawan stands debited to his personal
account.
f.
A contractors bill for the extension of premises amounting to Rs. 2,750 has been debited
to building repairs account.
g.
On 25th June, goods of the value of Rs. 500 were returned by Akashdeep and were taken
into stock but the returns were entered in the books under date 3rd July i.e. after the
expiration of the financial year on 30th June.
h.
A bill of Rs. 200 for old office furniture sold to Sethi was entered in the sales daybook.
i.
The periodical total of the sales book was cast short by Rs. 100.
j.
An amount of Rs. 80 received on account of interest was credited to commission account.
Solution
a
Wrong Entry
Correct Entry
Rectification Entry
Wrong Entry
Correct Entry
Rectification Entry
Wrong Entry
Correct Entry
Rectification Entry
Wrong Entry
Correct Entry
Rectification Entry
Wrong Entry
Correct Entry
Rectification Entry
Wrong Entry
Correct Entry
Rectification Entry
Wrong Entry
Trade Expenses A/c

To Cash A/c
Drawings A/c
To Cash A/c
Drawings A/c
To Trade Expenses A/c
200
Nathan A/c
To Sales A/c
Purchases A/c
To Nathan A/c
Sales A/c
Purchases A/c
To Nathan A/c
300
Purchases A/c
To Santhanam A/c
Santhanam A/c
To Sales A/c
Santhanam A/c
To, Purchases A/c
To Sales A/c
100
Cash A/c
To Mehrotra A/c
Cash A/c
To Malhotra A/c
Mehrotra A/c
To Malhotra A/c
150
Dhawan A/c
To Cash A/c
Salary A/c
To Cash A/c
Salary A/c
To Dhawan A/c
375
Building Repairs A/c

To Cash A/c
Building A/c
To Cash A/c
Building A/c
To Building Repairs A/c
200
200
200
200
200
300
300
300
300
300
600
100
100
100
200
100
100
150
150
150
150
150
375
375
375
375
375
2,750
2,750
2,750
2,750
2,750
2,750
No entry passed
135
Correct Entry
Rectification Entry
h
Wrong Entry
Correct Entry
Rectification Entry
500
XYZ A/c
To Sales A/c
XYZ A/c
To Furniture A/c
Sales A/c
To Furniture A/c
200
Wrong Entry
No entry passed
Correct Entry
Suspense A/c
To Sales A/c
Suspense A/c
To Sales A/c
Rectification Entry
j
Sales returns A/c

To Akashdeep A/c
Sales returns A/c
To Akashdeep A/c
Wrong Entry
Correct Entry
Rectification Entry
Cash A/c
To Commission A/c
Cash A/c
To Interest A/c
Commission A/c
To Interest A/c
500
500
500
200
200
200
200
200
100
100
100
100
80
80
80
80
80
80
QUESTIONS
1.
It is said that tallying of Trial Balance is not the conclusive proof of accuracy of the books
of account. Why ?
2.
What are errors in financial accounting ? What are the different types of errors ?
3.
What do you mean by Suspense Account? How is it operated in financial accounting?

Can the balance of Suspense Account appear in the Trial Balance in ideal situations?
4.
What are errors in financial accounting? Do all the errors affect the Trial Balance? State
the errors that affect the Trial Balance and the errors that do not affect the Trial Balance.
PROBLEMS
Q.1
Ganesh drew a Trial Balance of his operations for the year ended 31st March 1992. There was
a difference in the Trial Balance which he closed with a Suspense Account. On a scrutiny by
the Auditors, the following errors were found
a.
136
Purchases day book for the month of April 1991, was undercast by Rs. 1,000.
b.
Sales day book of October 1991 was overcast by Rs. 10,000.
c.
A furniture purchased for Rs. 8,100 was entered in the Furniture Account as Rs. 810.
d.
A bill for Rs. 10,000 drawn by Ganesh was not entered in the Bills Receivable Book.
e.
A machinery purchased for Rs. 10,000 was entered in the purchase day book.
Pass necessary journal entries to rectify the same and ascertain the difference in the Trial
Balance that was shown under the Suspense Account in respect of the above items.
Q.2
A bookkeeper while preparing his Trial Balance finds that the debit exceeds by Rs. 7,250.
Being required to prepare the final accounts, he places the difference to a Suspense Account.
In the next year, the following mistakes were discovered
a.
A sale of Rs. 4,000 has been passed through the Purchase daybook. The entry in
customers account has been correctly recorded.
b.
Goods worth Rs. 2,500 taken away by the proprietor for his use has been debited to
Repairs Account.
c.
A bill receivable for Rs. 1,300 received from Krishna has been dishonoured on maturity
but no entry passed.
d.
Salary Rs. 650 paid to a clerk has been debited in his Personal Account.
e.
A purchase of Rs. 750 from Raghubir has been debited to his account. Purchase Account
has been correctly debited.
f.
A sum of Rs. 2,250 written off as depreciation on furniture has not been debited to
Depreciation Account.
Draft the Journal Entries for rectifying the above mistakes and prepare Suspense Account.
Q.3
The accountant of X prepared the Trial Balance for the year ended 31st March 1996. But there
was a difference and the accountant put the difference in Suspense Account. Rectify the
following errors found and prepare the Suspense Account.
a.
The total of the Returns Outward book, Rs. 420 has not been posted in the ledger.
b.
A purchase of Rs. 350 from Y has been entered in the sale book. However, Ys account
has been correctly entered.
137
c.
A sale of Rs. 390 to Z has been credited to his account as Rs. 290.
d.
Old furniture sold for Rs. 5,400 has been entered as Rs. 4,500 in sales account.
e.
Goods taken by proprietor, Rs. 500 have not been entered in the books at all.
Q.4
A bookkeeper finds the difference in the Trial Balance amounting to Rs. 1,000 and puts it in
the Suspense Account. Later on he detects the following errors
a.
Purchased goods from Ravi but entered into Sales Book.
b.
Received one bill for Rs. 25,000 from Arun but recorded in Bills Payable Book.
c.
An item of Rs. 3,500 relating to prepaid rent account was omitted to be brought forward.
d.
An item of Rs. 2,000 in respect of purchase returns, had been wrongly entered in the
purchase book.
e.
Rs. 25,000 paid to Hari against our acceptance were debited to Harish Account.
f.
Bills received from Janaki for repairs done to radio Rs. 2,500 and radio supplied for
Rs. 45,000 were entered in the Purchase Book as Rs. 46,000.
Give rectifying journal entries with full narration and prepare Suspense Account.
Q.5
There is a difference in the Trial Balance of Shri Om. Subsequently, the following errors were
found to have been committed. Pass journal entries to rectify them and ascertain the difference
in the Trial Balance.
138
a.
A sale of Rs. 2,000 to Shanti & Co. was credited to their account.
b.
The Returns Inward Book had been cast Rs. 1,000 short.
c.
A sale of Rs. 10,000 had been passed through the Purchase Day Book. The customers
account, had, however been correctly debited.
d.
Rs. 3,750 paid for wages to workmen for making showcases had been charged to Wages
Account.
e.
A purchase of Rs. 6,710 had been posted to the debit of the creditors account as
Rs. 6,170. The creditor was Paras & Co.
Q. 6
There was difference in the Trial Balance of Shri Arihant which was put to newly opened
Suspense Account. Subsequently, the following mistakes were discovered. Pass journal entries
to rectify them and ascertain the difference in the Trial Balance.
a.
Materials costing Rs. 700 in the erection of machinery and the wages paid for amounting
to Rs. 400 were included in the Purchase Account and Wages Account respectively.
b.
Goods sold under credit terms Rs. 16,900 to Mohan were recorded properly in the Sales
Book but were debited to his account as Rs. 19,600 and carriage outward freight paid
Rs. 700 chargeable from him were posted to Sales Expenses Account.
c.
Sales Returns by Yogesh Rs. 2,300 were correctly recorded in the Sales Returns Book
from where they were debited to Yogesh Account by Rs. 3,200.
d.
Old furniture originally purchased for Rs. 1,800 written down to Rs. 1,100 was sold for
cash Rs. 1,700 and was credited to Furniture Account.
e.
Machinery purchased on credit Rs. 17,000 was recorded in Purchase Book and transport
charges for the machine Rs. 1,200 were debited to Trade Expenses Account.
Q.7
Give journal entries to rectify the following errors
a.
Rs. 2,500 paid for the purchase of a radio set for the personal use of the proprietor
debited to general expenses account.
b.
Rs. 1,300, the amount of sale of old machinery, has been posted to sales account.
c.
A sum of Rs. 160 paid by way of rent has been debited to landlords personal account.
d.
Rs. 245 cost of repairing the floor of room has been charged to buildings account.
e.
A payment of Rs. 250 made to Harish Brothers for cash purchase of goods from him
stands debited to his account.
Q.8
Rectify the following errors by passing necessary journal entries
a.
Goods taken by the proprietor Rs. 1,500 for gift to his daughter were not recorded at all.
b.
Rs. 1,500 received from Praveen against debts previously written off as bad debts have
been credited to his personal account.
139
c.
Received interest Rs. 150 posted to loan account.
d.
A cheque received from Amar, a debtor, for Rs. 2,000 was directly received by the proprietor
who deposited it into his personal bank account.
Q.9
While preparing the final accounts for the year ended 31st March 1995, Mr. Smart could not
get his Trial Balance agreed. He transferred the difference to Suspense Account and prepared
the final accounts. In April 1995, following errors were discovered in the books of accounts for
the year 1994-95
a.
The sales book for January 1995 was undercast by Rs. 1,000.
b.
Entertainment expenses Rs.150 incurred on 5th January 1995 were omitted to be posted
from cash book to the ledger.
c.
Discount column on the receipt side of the cash book for February 1995 was added as
Rs. 2,230 instead of Rs. 2,130.
d.
A purchase from Mr. Sumer for Rs. 8,200 on 3rd March 1995 was correctly recorded in
the purchase book. But the supplier was wrongly debited for the purchase.
Pass the necessary journal entries to rectify the above-mentioned errors without affecting the
profit for the year 1995-96. Also prepare Suspense Account and Profit & Loss Adjustment
Account. Assume that all the errors have been located.
Q.10
An accountant could not tally the Trial Balance. The difference was temporarily placed to
Suspense Account for preparing the final accounts. The following errors were discovered later
on
140
a.
The sales book was undercast by Rs. 350.
b.
Entertainment expenses Rs. 95 though correctly entered in the cash book were omitted
to be posted in the ledger.
c.
Commission of Rs. 25 paid was posted twice, once to discount account and again to
commission account.
d.
A sales of Rs. 139 to Ramnath, though correctly entered in the sales book was posted
wrongly to his account as Rs. 193.
You are required to pass the necessary journal entries in the books of the next accounting
year so as not to affect the profit of that year.
Q.11
The Trial Balance of N Ltd. does not tally. In order to give it a semblance of agreement, the
accountant of the company transfers the difference to a newly opened Suspense Account.
Later on, he discovers the following errors
a.
An item of Rs. 5,850 paid for purchase of a new typewriter for the accounts department
has been wrongly passed through the purchases book.
b.
An item of Rs. 780 in the sales book has been posted as Rs. 960 in the customers
account.
c.
An addition in the returns inward book has been cast Rs. 240 short.
d.
An item of Rs. 450 appearing in the discount column on the credit side of the cash book
has been posted to the credit side of the concerned personal account as Rs. 540.
e.
A bill of exchange for Rs. 2,650 accepted by R & Co. and later discounted with the bank
has been returned by the bank as dishonoured. On dishonour, the amount of the bill has
been debited to sales account.
Give journal entries to rectify the above mentioned errors and also show the Suspense Account.
Q.12
Pass journal entries to rectify the following errors
a.
A purchase amounting to Rs. 1,000 made for a staff member was recorded in the purchases
book.
b.
Wages paid to workers for installing machinery, Rs. 750 were debited to wages account.
c.
A dishonoured bill receivable for Rs. 5,000 returned by the bank with whom it was
discounted was credited to bank and debited to bills receivable account.
d.
A sum of Rs. 1,000 drawn by the proprietor for his personal use was debited to traveling
expenses account.
141
Q.13
Pass journal entries to rectify the following errors
a.
A sum of Rs. 100 paid to Suresh was debited to Subhash.
b.
A credit sale of Rs. 587 was recorded in the sales book as Rs. 857.
c.
Goods sold to Prem for Rs. 170 were returned by him, but no entry was passed in the
books.
d.
A bill receivable for Rs. 2,000 accepted by Vimal was recorded in bills payable book.
e.
Repairs of furniture amounting to Rs. 500 were debited to furniture account.
Q.14
Pass journal entries to rectify the following errors and prepare Suspense Account.
a.
Rs. 1,080 received from Mohan was posted to the debit of his account.
b.
Rs. 200 being purchase returns were posted to the debit of purchases account.
c.
Rs. 400 received as discount was posted to the debit of discount account.
d.
Rs. 1,148 paid for repairs of motor car was debited to motor car account as Rs. 148.
e.
Rs. 400 paid to Suresh was debited to Satish.
Assume that there are no other errors.
Q.15
On 28th February 1999, the Trial Balance of X did not agree. X put the difference in a newly
opened Suspense Account. Subsequently, following errors were located
142
a.
The returns inward book for January 1999 had been cast Rs. 1,000 short.
b.
A purchase of Rs. 1,671 had been posted to the debit of the creditors account as
Rs. 1,617. The creditor is Panna & Co.
c.
A sale of Rs. 2,000 to Singhi & Co. was credited to the account of the customer.
d.
A sale of Rs. 4,000 has been passed through the purchase book. The customers account
has however been correctly debited.
e.
While carrying forward the total of sales book from one page to the next, the amount was
written as Rs. 1,76,658 instead of Rs. 1,67,568.
Pass journal entries to rectify the above-mentioned errors. Also prepare the Suspense Account
assuming that all the errors have been located.
Q.16
An accountant prepared a Trial Balance on 31st January 2000, which revealed a difference in
the books of account. He put the difference in a newly opened Suspense Account. During
February 2000, he detected the following errors
a.
The total of the returns outward book, Rs. 4,200 had not been posted in the ledger.
b.
A purchase of Rs. 3,500 from Y had not been entered in the purchase book. However,
Ys account had been correctly credited with the amount.
c.
A sale of Rs. 3,900 to Z had been credited to his account as Rs. 2,900.
d.
Furniture sold for Rs. 5,400 had been entered as Rs. 4,500 in the sales book.
e.
Goods worth Rs. 500 taken by the proprietor for personal use had not been recorded at
all.
f.
Wages paid for an installation of machinery Rs. 1,000 had been debited to wages account.
Pass journal entries to rectify the abovementioned errors and prepare Suspense Account
assuming that all the errors have been located.
Q.17
Give journal entries to rectify or adjust the following in the books of both the head office and the
branch.
a.
Goods costing Rs. 16,000 purchased by branch, but payment made by head office. The
head office has debited the amount to its own purchase account.
b.
Branch paid Rs. 30,000 as salary to a visiting head office official. The branch has debited
the amount to salaries account.
c.
Depreciation, Rs. 50,000 in respect of branch assets whose accounts are kept in the
head office books is to be recorded by both the parties.
d.
Expenses Rs. 70,000 to be charged to the branch for work done on its behalf by the
head office.
143
Q.18
On finding a difference between two sides of the Trial Balance, the accountant transferred the
excess debit of Rs. 770 to a suspense account. Subsequently, the following errors were
detected. Give journal entries to rectify the errors and show the suspense account.
1.
Repairs to machinery Rs. 2,000 were debited to Machinery Account.
2.
A sale of Rs. 900 to Patel was recorded in the Purchases Book.
3.
The total of the Returns Inwards Book Rs. 400 was not posted.
4.
A purchase of Rs. 590 from Sathe was posted to his account as Rs. 950.
5.
The bank column of the receipt side of the cash book was undercast by Rs. 110.
6.
A cash sale of Rs. 200 to Ramesh was entered both in the cashbook and sales book.
7.
A credit purchase of Rs. 300 from Satish was omitted to be recorded.
8.
Cash Rs. 150 paid to Brijmohan was posted twice to his account.
9.
A credit balance of Rs. 450 to Malasinghs account was carried forward as Rs. 540 on
the debit side.
10. The name of Vinod, a creditor, to whom we owed Rs. 500 was omitted from the list of
sundry creditors.
Q.19
Rectify the following errors
144
1.
Carriage on machinery is debited to Carriage Account Rs. 100.
2.
Goods purchased from Sahani Rs. 531 was debited to his account as Rs. 351.
3.
A television purchased for the workers canteen in the factory for Rs. 25,000 was debited
to Factory Expenses.
4.
An amount of Rs. 15,000 paid for the construction of a new hall in the building was
debited to Repairs Account.
5.
The total of the Sales Book for the month of February was cast short by Rs. 10.
6.
A credit sale of Rs. 575 to Mahendra was debited to Mohinders Account.
7.
A sum of Rs. 500 paid to Poonawalla for salary was debited to his personal account.
8.
A credit sale of Rs. 1,000 to Rashid was correctly entered in the Sales Book but was
posted to the credit of his account in the ledger as Rs. 100.
9.
Goods sold to Devidas Rs. 590 was recorded in the Sales Book as Rs. 950.
NOTES
145
NOTES
146
Chapter 6
COST
ACCOUNTANCY
[BASIC CONCEPTS AND PRINCIPLES]
INTRODUCTION :
The Institute of Cost and Management Accountants, London has defined the Cost Accountancy
as The Application of Costing and Cost Accounting principles, methods and techniques to
the science, art and practice of cost control and the ascertainment of profitability as well as
presentation of information for the purpose of managerial decision making.. The analysis of
the above definition reveals the following facts.
(1)
Cost Accountancy is a science, art and practice of a Cost Accountant. Science indicates
the possession and the application of relevant systematic knowledge. Art indicates the
skill and ability of the Cost Accountant. Practice indicates a continuous effort on the part
of the Cost Accountant.
(2)
The terms costing and cost accounting should not be confused. Costing indicates the
process of ascertaining the costs which can be done arithmetically also. Cost accounting
indicates the process of recording the costs in a formal and systematic manner with the
intention of preparing statistical data therefrom to ascertain the cost.
(3)
The objects of Cost Accountancy can be threefold.

(a)
Ascertainment of cost and profitability with the help of various principles, methods
and techniques.
(b)
Cost control This indicates the process of controlling the costs of operating the
business. This process, in turn, involves the following stages. To plan the operations
(which can be done by the establishment of budgets and standards), execute the
plans, measuring the actual performance, comparison of planned and actual
performance, computing the variations between planned and actual performance
and taking the decisions to maintain favourable variations or to remove unfavourable
variations.
Cost Accountancy [Basic Concepts and Principles]
147
(c)
Presentation of information to enable managerial decision making. Unless and until

the results of any study or action are presented correctly to the person who takes
the decision in respect of the same, the study has no meaning.
CONCEPT OF COST CENTRE :

Cost Centre is defined as a location, person, or item of equipment (or a group of these) in or
connected with an undertaking, in relation to which costs may be ascertained and used for the
purpose of cost control. Correct identification of a cost centre is pre-requisite for the successful
implementation of cost accounting process as the costs are ascertained and controlled with
respect to the cost centres. Similarly, correct identification of cost centre facilitates the fixation
of responsibility in a correct manner. Eg. A person in-charge of a cost centre may be held
responsible for the proper functioning and cost control in relation to that cost centre. As cost
centres facilitate this control function, in many cases, they are termed as Responsibility
Centres. There may not be any fixed principle for deciding the number and size of cost
centres. It depends upon the nature and size of organisation, expenditure involved, requirements
of management from cost control point of view and so on. However, following pattern of
classification may be followed to decide the cost centres.
(1)
Impersonal and Personal Cost Centres :

An impersonal cost centre consists of location or item of equipment (or group of these).
Eg. A region of sales, a branch, a department, a grinding machine and so on. A personal
cost centre consists of a person or a group of persons. Eg. Finance Manager, Sales
Manager, Works Manager and so on.
(2)
Production and Service Cost Centres :

Production cost centre is the one where the production activity is carried on. Eg. Machine
shop, Paint shop, Assembly shop and so on.
Service cost centre is the one which assists the production activity. Eg. Store Dept.,
Internal Transport Dept., Labour Office, Maintenance Dept., Accounts/Costing Dept.,
and so on.
CONCEPT OF COST :
The term cost indicates the amount of expenditure (actual or notional) incurred on or attributable
to, a given thing.
The term cost can be viewed from various angles.
148
(1)
Direct Cost and Indirect Cost :

Direct Cost indicates that cost which can be identified with the individual cost centre. It
consists of direct material cost, direct labour cost and direct expenses. It is also termed
as Prime Cost.
Indirect Cost indicates that cost which cannot be identified with the individual cost centre.
It consists of indirect material cost, indirect labour cost and indirect expenses. It is also
termed as overheads. As it is not possible to identify these costs with individual cost
centres, such identification is done in the indirect way by following the process of allocation,
apportionment and absorption. (It is discussed in details in the following chapters).
(2)
Fixed, Variable and Semi-variable/Semi-fixed Cost :

Fixed cost indicates that portion of total cost which remains constant at all the levels of
production, irrespective of any change in the later. As the volume of production increases,
per unit fixed cost may reduce, but not the total fixed cost.
Variable cost indicates that portion of the total cost which varies directly with the level of
production. Higher the volume of production, higher the variable cost and vice versa,
though per unit variable cost remains constant at all the levels of production.
Semi-variable or semi-fixed cost indicates that portion of the total cost which are partly
fixed and partly variable in relation to the volume of production.
(3)
Controllable Cost and Uncontrollable Cost :

Controllable cost indicates that cost which can be controlled by a specific number of
person(s) in the organisation. Eg. A person in charge of a responsibility centre may be in
the position to control the costs in relation to that responsibility centre.
Uncontrollable cost indicates that cost which cannot be controlled by a specific number
of person(s) in the organisation. Eg. The costs relating to one responsibility centre cannot
be controlled by a person who is in-charge of another responsibility centre.
It should be noted here that a clear-cut distinction between controllable and uncontrollable
costs may not be possible. The cost which is controllable for one person may not be
controllable by another one. In fact, no cost is completely uncontrollable. The degree of
controllability varies in relation to a particular individual and a level of management. In a
very broad sense, it can be said that the variable costs are controllable at the lower level
of management while fixed costs are controllable at the top level of management.
149
(4)
Normal Cost and Abnormal Cost :

Normal Cost indicates that cost which is normally incurred at a certain level of output
under normal circumstances.
Abnormal cost indicates that cost which is normally not incurred at a certain level of
output under normal circumstances.
SPECIAL TYPES OF COST :

(a)
Opportunity Cost :
In very simple language, opportunity cost is the cost of opportunity foregone. The resource
like men, material, machine, money etc. may be having various alternative uses each
one having some specific yield or return. However, if they are used in one particular way,
they cannot be used in any other way. Opportunity cost refers to the return or yield
which is not available if the resources are used in any specific manner. Eg. Mr. A has Rs.
1,00,000 to invest. He is having two options open.
(i)
Keep the same with some Bank in Fixed Deposit and get the interest of 10% p.a.
(ii)
Invest the money in the business and get the return on investment of 12%.
If Mr. A decides to invest the money in business, he cannot get the interest on
Fixed Deposit from Bank. As such, opportunity cost of investing the money in the
business is in the form of lost interest on Fixed Deposits with the Bank. It should
be noted that the opportunity cost itself finds no place in the accounting process.
However, it is required to be considered in the decision making process, for the
comparison purpose. The returns available from a proposal should be more than
the cost of opportunity lost, then and then only the proposal can be accepted.
(b)
Differential Cost :
Differential cost indicates increased or decreased cost due to the increased or decreased
volume of operations. While assessing the acceptability of a proposed change, the
differential costs are compared with differential revenues, and so long as differential
revenues are more than the differential costs, the proposed change may be accepted.
(c)
Sunk Cost :
Sunk cost indicates historical cost which is incurred in past. This type of cost is normally
not relevant in the decision-making process. Eg. While deciding about the replacement
of a machine, the depreciated book value of the machine may not be relevant being in the
form of sunk cost.
150
INSTALLATION OF COSTING SYSTEM :

At the outset, it should be noted that if it is decided to install a costing system in an organisation
there may not be any standard type of costing system applicable. The details of costing
system may be required to be worked out in such a way that they satisfy the individual
requirements of the organisation. Following factors will have to be considered before installing
a costing system.
(a)
Nature of the Product :

Before installing the costing system, the nature of product in respect of which the system
is to be installed will have to be studied. If the product is material intensive, more stress
may be necessary on inventory control procedures, if the product is labour intensive,
more stress may be necessary on control procedures and so on.
(b)
Nature of the Organisation :

The nature of the organisation may be required to be studied from the various angles.
(c)
(1)
Size and layout of the factory.
(2)
Organisational structure of the organisation.
(3)
The procedures presently followed in the respect of accounting of material cost,

labour cost and overheads.
(4)
Management requirements from the cost control point of view.
Manufacturing Process :
Before installing the costing system, the technical process involved in the manufacturing
of the product will have to be studied. This may involve the study from the stage of
designing of the product, the quantity, quality and mix of the materials used, the degree
of automation involved, the production control techniques implemented, the degree of
complexities involved in the production process and so on.
(d)
Simplicity and Cost :

The costing system to be installed should be simple to understand and easy to operate.
The costing system should be economic in terms of cost of installing and operating the
system, and the results obtained therefrom should justify the cost.
151
(e)
Reporting systems :
The costing system should be designed in such a way that it generates proper reports in
a proper way to facilitate cost control decisions from the managements side. The reporting
system should be based upon the principle of Management by Exception. Forms and
records required to be maintained to facilitate correct reporting should be designed in
such a way that it involves minimum clerical work and minimum cost.
Some problems may arise while installing a costing system in an organisation. However, they
are faced mainly where the system is not properly planned, executed and communicated.
These problems are definitely not of the costing principles as such and can easily be overcome
by having systematic planning and communication procedures. The problems which are usually
faced while installing a costing system can be stated as below.
152
(1)
The costing system may not be suitable considering the nature of product and nature of
business.
(2)
The employees and the executives may resist the installation of the costing system
feeling that it is meant for pointing out their drawbacks. This arises only out of ignorance
and suspicion.
(3)
Lack of cost consciousness among the various levels of management.
(4)
The cost involved in installing a costing system may be too high.
(5)
Laxity on the part of various employees to complete the forms of cost office and to
forward them to the cost office.
QUESTIONS
1.
Explain the nature of Cost Accounting.

Explain the factors which need to be considered for installing a costing system for a
medium sized engineering organisation.
2.
Write short notes on

a)
Cost Centre
b)
Opportunity Cost
153
NOTES
154
Chapter 7
ELEMENTS OF COSTS
In case of a typical manufacturing type of operation, the activity may consist of conversion of
raw material in the form of finished goods with the help of labour and other services and selling
the finished goods in the market to earn the profits. In order to interpret the term cost correctly
and to ascertain the cost with respect to the centres, the cost attached with the manufacturing
process may be subdivided into what is known as Elements of Cost. Broadly there can be
three elements of costs.
(A) Material :
This is the cost of commodities and materials used by the organization. It can be direct or
indirect.
Direct Material indicates that material which can be identified with the individual cost centre
and which becomes an integral part of the finished goods. It basically consists of all raw
materials, either purchased from ourside or manufactured in house.
Indirect Material indicates that material which cannot be identified with the individual cost
centre. This material assists the manufacturing process and does not become an integral part
of finished goods. The examples of this type of material may be consumable stores, cotton
waste, oils and lubricants, stationery material etc.
(B) Labour :
This is the cost of remuneration paid to the employees of the organisation. It can be direct or
indirect.
Direct Labour Cost indicates that labour cost which can be identified with the individual cost
centre and is incurred for those employees who are engaged in the manufacturing process.
Indirect Labour Cost indicates that labour cost which cannot be identified with the individual
cost centre and is incurred for those employees who are not engaged in the manufacturing
process but only assist in the same. The examples of this type of cost are wages paid to
foreman/storekeeper, salary of works manager, Accounts/Personnel department salaries etc.
Elements of Costs
155
(C) Expenses :
This is the cost of services provided to the organisation (and the notional cost of assets
owned). It can be direct or indirect.
Direct Expenses are those expenses, which can be identified with the individual cost centres.
The examples of these expenses are hire charges of machinery/ equipments required for a
particular job, cost of defective work for a particular job etc.
Indirect Expenses are those expenses, which cannot be identified with the individual cost
centres. The examples of these expenses are rent, telephone expenses, insurance, lighting
etc.
The above elements of cost can be shown as below.
Cost
Material
Direct
Labour
Indirect
Direct
Expenses
Indirect
Direct
Indirect
The aggregate of Direct Material Cost, Direct Labour Cost and Direct Expenses is termed as
Prime Cost.
The aggregate of Indirect Material Cost, Indirect Labour Cost and Indirect Expenses is termed
as Overheads.
Overheads :
As discussed above, the aggregate of Indirect Material cost, Indirect Labour cost and Indirect
Expenses is termed as Overheads. For the proper interpretation and presentation of cost,
the term overheads may be further classified as below.
(a)
Factory Overheads (Also termed as production/works/manufacturing overheads.)
(b)
Office and Administration Overheads.
(c)
Selling and Distribution Overheads.
(a)
Factory Overheads :
These overheads consist of all overhead costs incurred from the stage of procurement of
material till the stage of production of finished goods. They include :
l
156
Indirect Material such as consumable stores, cotton waste, oil and lubricants etc.
(b)
Indirect Labour Cost such as wages paid to foreman/storekeeper, works managers

salary etc.
Indirect Expenses such as carriage inward cost, cost of factory lighting/power

expenses, rent/insurance/repairs for factory building/machinery, depreciation on
factory building or machinery etc.
Office and Administration Overheads :

These overheads consist of all overhead costs incurred for the overall administration of
the organization. They include :
(c)
Indirect Material such as stationery items, office supplies etc.
Indirect Labour cost such as salaries paid to Accounts and Administration staff,
Directors remuneration etc.
Indirect Expenses such as postage/telephone, rent/insurance/repairs/depreciation

on office building, general lighting, legal/audit charges, bank charges etc.
Selling and distribution Overheads :

These overheads consist of all overhead costs insured from the stage of final manufacturing
of finished goods till the stage of sale of goods in the market and collection of dues from
the customers. They include :
l
Indirect Material such as packing material, samples etc.
Indirect Labour like salaries paid to sales personnel, commission paid to sales
manager etc.
Indirect Expenses like carriage outwards, warehouse charges, advertisement, bad

debts, repairs and running of distribution van, discount offered to customers etc.
Elements of Costs
157
The above classification of overheads can be shown as below :

Indirect Material
Factory
Indirect Labour
Indirect Expense
Indirect Material
Overheads
Office/Administration
Indirect Labour
Indirect Expense
Indirect Material
Selling & Distribution
Indirect Labour
Indirect Expense
Cost Sheet/Cost Statement :

The various elements/components of the cost as discussed above can be presented in the
form of a statement, popularly known as Cost Sheet or Cost Statement. The cost sheet
may be prepared separately for each cost centre and may have the columns like cost per unit
or cost of previous period etc.
A Proforma cost sheet is shown below :
Direct Material Cost
Direct Labour cost
Direct Expenses
PRIME COST
Add : Factory Overheads
FACTORY/WORKS COST
Add : Office and Administration Overheads
TOTAL COST
Add : Selling and Distribution Overheads
COST OF SALES
Add : Profit
SALES
158
The above relationship among the various elements of costs can be explained in a better way
with the help of following diagram.
PROFIT
SELLING & DISTRIBUTION
OVERHEADS
ADMINISTRATION
OVEREHEADS
SALES
COST OF SALES
DIRECT
MATERIAL
TOTAL COST
DIRECT
LABOUR
PRIME COST
DIRECT
EXPENSES
FACTORY COST
FACTORY
OVERHEADS
Note :
The difference between sales and factory/works cost is termed as Gross Profit and the
difference between sales and cost of sales is termed as Net Profit or Operating Profit. As
such, the difference between Gross Profit and Office and Administration Overheads and Selling
and Distribution may be different from the Net Profit or Operating Profit. This Net Profit may
be different from the net Profit as disclosed by the financial statement in the form of Profit and
Loss Account. This is due to the fact that the Profit and Loss Account considers the various
non-operating incomes/expenses or incomes/expenses of purely financial nature (as discussed
below) while they may be ignored by the cost statement.
(a)
Non-operating/Financial Incomes :
These represent incomes which arise not as a part of regular operations of the organisation.
Eg. Profit on the sale of assets/investment, dividend received, windfall income etc. Due
to these, the operating profit as per cost statement may be less than profit as per Profit
and Loss Account.
(b)
Non-operating/Financial Expenses :
These represent expenses which arise not as a part of regular operations of the
organisation. Such expenses may be in the form of those incurred as a result of policy.
Elements of Costs
159
Eg. loss on the sale of assets/investment, good-will/ preliminary expenses written off,
provision for Income Tax, Interest paid, Dividend paid etc. Due to these, the operating
profit as per cost statement may be more than profit as per Profit and Loss Account.
As such cost structure may also be presented as below.
Sales
Less :
Factory/Works Cost
Gross Profit
Less :
Office and Administration Overheads

Selling and Distribution Overheads
Operating Profit
Less :
Non-Operating/Financial Expenses
Add :
Non-Operating/Financial Income
Net Profit (As per Profit and Loss Account)
It goes without saying that if an organisation maintains cost records and financial records
separately, there may be a need to reconcile the profits as disclosed by the cost records and
the profit as disclosed by the financial records.
ILLUSTRATIVE PROBLEMS
(1)
From the following list of balances, prepare a statement showing Cost of Sales, Gross
Profit, Operating Expenses, Operating Profit and Net Profit.
Rs.
Sales
7,80,000
Purchases
4,83,375
Sales Returns
Salaries :
30,000
Office
40,350
Selling
22,950
Rent and Taxes :
Office
2,700
Selling
1,350
Stationery and Postage

Depreciation
160
63,300
4,050
3,850
13,950
Advertising
4,700
Selling expenses
2,350
Travelling expenses
3,000
Opening Stock
1,14,375
Sundry Expenses : Office

Selling
16,500
8,250
Closing Stock
24,750
1,47,750
Dividend on shares
13,500
Profit and sale of shares
4,500
Loss on sale of shares
6,000
Solution :
COST STATEMENT
(A) Sales
Rs.
Gross Sales
Rs.
7,80,000
Less : Sales Returns
30,000
Net Sales
7,50,000
(B) Prime Cost (Material consumed)

Opening Stock
1,14,375
Add : Purchases
4,83,375
5,97,750
Less : Closing stock
1,47,750
4,50,000
(C) Gross Profit (i.e. A-B)
3,00,000
(D) (a) Office and Administration Overheads

-
Salaries
40,350
Rent and Taxes
2,700
Stationery and Postage
3,850
Depreciation
Travelling Expenses
Sundry Expenses
13,950
3,000
16,500
80,350
Elements of Costs
161
(b) Selling and Distribution Overheads

-
Salaries
22,950
Rent and Taxes
1,350
Advertising
4,700
Selling Expenses
2,350
Sundry Expenses
8,250
39,600
(E)
Operating Profit (i.e. C-D)
(F)
(a) Less : Non-operating Expenses

Dividend on shares
Loss on sale of shares
1,19,950
1,80,050
13,500
6,000
19,500
1,60,550
(b) Add : Non-operating Income

Profit on sale of shares
4,500
(G) Net Profit
1,65,050
Notes :
(a)
From the available details, it appears that the above activity is a trading activity. As such
there will be no factory overheads and prime cost will consist of only material cost.
(b)
In want of sufficient information, depreciation and travelling expenses are treated as

office and administration overheads.
(c)
Dividend on shares may indicate the non-operating income also. However, in want of
sufficient information, it is treated as dividend paid by the company i.e. a part of nonoperating expenses.
(2)
From the books of accounts of M/s. Aryan Enterprises, the following details have been
extracted for the year ending March, 1994.
Rs.
Stock of Materials
1,88,000
Closing
2,00,000
Materials purchased during the year
8,32,000
Direct Wages paid
2,38,400
Indirect Wages
162
Opening
16,000
Salaries to administrative staff
40,000
Freights
Inward
32,000
Outward
20,000
Cash Discounts allowed
14,000
18,800
Repairs to Plant & Machinery
42,400
Rent, Rates and Taxes
12,000
Factory
Office
6,400
Travelling Expenses
12,400
Salesmens Salaries and Commission
33,600
Depreciation Plant & Machinery
28,400
Furniture
2,400
Directors Fees
24,000
Electricity Charges (Factory)
48,000
Fuel (for boiler)
64,000
General Charges
24,800
Managers Salary
48,000
The managers time is shared between the factory and the office in the ratio of 20:80.
From the above details, you are required to prepare :a.
Prime Cost
b.
Factory Overheads
c.
Factory Cost
d.
Administration Overheads
e.
Selling Overheads
f.
Total Cost
Solution :
COST SHEET
Direct Materials Cost
Rs.
Opening Stock
1,88,000
Add : Purchases
8,32,000
Less : Closing Stock
2,00,000
Rs.
8,20,000
Add : Freight Inward
Elements of Costs
32,000
163
Rs.
Rs.
8,52,000
Direct Wages
2,38,400
PRIME COST
10,90,400
Factory Overheads
Indirect wages
16,000
Repairs to Plant & Machinery
42,400
12,000
Depreciation Plant & Machinery
28,400
Electricity Charges
48,000
Fuel for boiler
64,000
Managers Salary
9,600
2,20,400
FACTORY COST
13,10,800
Salaries
Travelling Expenses
Depreciation Furniture
40,000
6,400
12,400
2,400
Directors Fees
24,000
General Charges
24,800
Managers Salary
38,400
1,48,400
OFFICE COST
14,59,200
Selling Overheads
Freight Outward
20,000
Cash Discount allowed
14,000
18,800
Salesmens Salary & Commission
33,600
86,400
TOTAL COST
164
15,45,600
(3)
An advertising agency has received an enquiry for which you are supposed to submit the
quotation. Bill of Materials prepared by the Production Department for the job states the
following requirement of material :
Paper
10 reams @ Rs. 1800 per ream
Ink & Other printing material
Rs. 5,000
Other consumables
Rs. 3,000
Some photography is required for the job. The agency does not have a photographer as an
employee. It decides to hire a professional photographer who is to be paid professional fees of
Rs. 10,000.
Estimated job card prepared by the Production Department specifies that services of the
following employees will be required for the execution of the job. Monthly remuneration payable
to these employees as indicated by the Personnel Department is also given.
Artist
80 hours. Paid Rs. 12,000 p.m.
Copywriter
Client Servicing
You can assume that a month consists of 25 working days and one working day consists of
6 working hours.
An amount of Rs. 4,000 will be required for the cost of primary packing material.
Production overheads are likely to be 40% of direct cost while selling and administration
overheads are likely to be 25% of production cost. The agency expects the profit of 10% on
basic quotation price.
COST SHEET
Rs.
Rs.

Paper
18,000
Ink & Other printing material
5,000
Other Consumables
3,000
Primary Packing Material
4,000
30,000
Direct Labour Cost

Artist
6,400
Copywriter
5,000
Client Servicing
1,800
13,200
Elements of Costs
165
Direct Expenses
Photography Charges
10,000
DIRECT COST
53,200
Production Overheads
21,280
PRODUCTION COST
74,480
Selling & Administration Overheads
18,620
TOTAL COST
93,100
Profit
10,344
QUOTATION PRICE
(4)
1,03,444
Pune Equipments Ltd. manufactured and sold 1,000 refrigerators in year ending
31 December, 1984. The Trading and Profit & Loss Account is as below:
Trading and P&L Account for the year ending 31.12.84.
To, Cost of material

To, Direct wages
To, Manufacturing Cost
To, Gross Profit
80,000
By, Sales
4,00,000
1,20,000
50,000
1,50,000
4,00,000
To, Mgn. & Staff Salary
60,000
To, Rent, Rates etc.
10,000
To, Selling Expenses
30,000
To, General Expenses
20,000
To, Income Tax

To, Net Profit
4,00,000
By, Gross Profit
1,50,000
5,000
25,000
1,50,000
1,50,000
For the year ending 31.12.85, it is estimated that :
166
1.
Output and sales will be 1,200 refrigerators.
2.
Prices of the materials will rise by 20% on the previous years level.
3.
Wages will rise by 5%.
4.
Manufacturing cost will rise in proportion to combined costs of materials and wages.
5.
Selling cost per unit will remain unchanged.
6.
Other expenses will remain unaffected by the rise in output.

You are required to prepare a cost statement showing the price at which each refrigerator
should be marked so as to show profit of 10% on the selling price.
Solution :
Cost Statement for the Year Ending 31.12.85
(Base - 1,200 Refrigerators)
Per Unit
Rs.
Total
Rs.
Material Cost
96.00
1,15,200
Direct Wages
126.00
1,51,200
Prime Cost
222.00
2,66,400
55.50
66.600
277.50
3,33,000
Management & Staff Salary
50.00
60,000
Rent/Taxes and General Expenses
25.00
30,000
Selling Expenses
30.00
36,000
382.50
4,59,000
42.50
51,000
425,00
5,10,000
Manufacturing Cost (25% of Prime Cost)

Factory Cost
Cost of Sales
Profit (1/9th of Total Cost)
Sales
Note :
(1)
Material Cost and Direct Cost increases both due to increase in volume and increase in
prices.
(2)
Calculation of manufacturing cost percentage Present Materials Cost
Rs.
80,000
Present Direct Wages
Rs. 1,20,000
Present Prime Cost
Rs. 2,00,000
Present Manufacturing Cost
Rs.
50,000
Manufacturing Cost is 25% of Prime Cost.

(3)
Expenditure in the form of income tax will be ignored being non-operating expenditure.
Elements of Costs
167
(5)
The standard production for a particular work order is 20 units per day and piece rate
wages is 60 paise per unit if daily production is 20 units or more. The rate is 50 paise per
unit if production is less than 20 units. Cost of material is 30 paise per unit. It is proposed
to charge factory overhead under one of the following methods.
(i)
100% on labour cost.
(ii)
80% on prime cost.
Tabulate the above data in the form of a suitable statement and indicate in the factory
cost per unit, under each of the above methods if the daily production is (a) 15 units
(b) 20 units (c) 25 units.
Solution :
COST SHEET
(a) No. of units produced per day
15
20
25
(b) Material cost (Rs)
4.50
6.00
7.50
(c) Labour cost (Rs)
7.50
12.00
15.00
12.00
18.00
22.50
(d) Prime cost i.e. b+c

Alternative I
(a) No. of units produced per day
(b) Prime Cost (Rs)
(c) Factory overheads (Rs)
(d) Total factory cost i.e. b+c
(e) Factory cost per unit i.e. d/a (Rs)
Alternative II
15
20
25
15
20
25
12.00
18.00
22.50
12.00
18.00
22.50
7.50
12.00
15.00
9.60
14.40
18.00
19.50
30.00
37.50
21.60
32.40
40.50
1.30
1.50
1.50
1.44
1.62
1.62
Note :
According to Alternative I, Factory Overheads are charged
@ 100% on Labour Cost.
According to Alternative II, Factory Overheads are charged.
@ 80% on Prime Cost.
168
(6)
X Ltd. manufactures four brands of toys A, B, C and D. If the Company limits the
manufacture to just one brand, the monthly production will beA - 50000 Units
B - 100000 Units
C - 150000 Units
D - 300000 Units
You are given the following set of information, from which you are requested to find out the
profit or loss made on each brand showing clearly, the following elements.
(a)
Direct cost
(b)
Works cost
(c)
Total cost
Brands
6,750
18,000
40,500
94,500
Direct Wages (Rs.)
15,000
27,500
37,500
1,05,000
Direct Material Cost (Rs.)
50,000
92,500
1,27,500
3,80,000
20
15
10
Monthly Production (units)
Selling Price Per Unit (Rs.)
Factory overhead expenditure for the month was Rs. 1,62,000. Selling and distribution cost
should be assumed @ 20% of works cost. Factory overhead expenses should be allocated to
each brand on the basis of the units which could have been produced in a month when a single
brand production was in operation.
Solution :
From the information given, it is observed that
One unit of B is equivalent to 2 units of A.
One unit of C is equivalent to 3 units of A
One unit of D is equivalent to 6 units of A
Expressing the actual production in terms of unit equivalents of product A
Product A
6,750
units.
Product B
9,000
units equivalent of A
Product C
13,500
Product D
15,750
45,000
Elements of Costs
169
The factory overheads of Rs. 1,62,000 are to be distributed over 45,000 equivalent units of
product A. As such rate of factory overheads for one unit of Product A will be
Rs. 1,62,000
45,000 units
= Rs. 3.60/per unit
As such, per unit factory overheads for other products will be Product B - Rs. 3.60/2 = Rs. 1.80/ per unit.
Product C - Rs. 3.60/3 = Rs. 1.20/ per unit.
Product D - Rs. 3.60/6 = Rs. 0.60/ per unit.
On this basis, the cost sheet for each product can be worked out as below.
A
(a) Direct Material Cost
50,000
92,500
1,27,500
3,80,000
(b) Direct Wages
15,000
27,500
37,500
1,05,000
(c) Total Direct Cost i.e. a+b
65,000
1,20,000
1,65,000
4,85,000
(d) Factory Overheads
24,300
32,400
48,600
56,700
(e) Works cost i.e. c+d
89,300
1,52,400
2,13,600
5,41,700
(f)
17,860
30,480
42,720
1,08,340
1,07,160
1,82,880
2,56,320
6,50,040
6,750
18,000
40,500
94,500
20
15
10
1,35,000
2,70,000
4,05,000
7,56,000
27,840
87,120
1,48,680
1,05,960
Selling/Distribution overheads
(g) Cost of Sales e+f

(h) Units Sold/Produced
(i)
Units Selling Price - Rs.
(j)
Total Sales Rs.
(k) Profit i.e. j-g

(7)
A manufacturing company has an installed capacity of 1,20,000 units per annum. The
cost structure of the product manufactured is as under
1.
Variable Cost (Per unit)

Materials
Rs. 8
Labour (subject to a minimum
2.
170
of Rs. 56,000 per month)
Rs. 8
Overheads
Rs. 3
Fixed overheads Rs. 1,04,000 per annum
3.
Semi variable overheads Rs. 48,000 per annum at 60% capacity which increase by Rs.
6,000 per annum for increase of every 10% of the capacity utilization or any part thereof.
The capacity utilisation for the next year is estimated at 60% for 2 months, 75% for 6 months
and 80% for the balance part of the year. If the company is planning to have a profit of 25% on
the selling price, calculate the estimated selling price for each unit of production. Assume that
there is no opening or closing stock.
Solution :
Capacity Utilisation
60%
75%
80%
6000
7500
8000
Months
No. of units
Hence, total number of units will be

6000 x 2 months + 7500 units x 6 months + 8000 units x 4 months = 89,000 units
Total
Materials (Rs.)
Labour
Overheads
Semi-variable Overheads
96,000
360,000
256,000
7,12,000
112,000
360,000
256,000
7,28,000
36,000
135,000
96,000
2,67,000
8,000
30,000
20,000
58,000
Fixed Overheads
1,04,000
Cost of Production
18,69,000
Per Unit Cost of Production i.e. 18,69,000/89,000 = Rs. 21

As profit is 25% on the selling price, selling price will be Rs. 28 per unit.
(8)
AB & Co. manufactures two types of pens P and Q. The cost data for the year ended
30th September, 1990 is as follows
Direct Materials
Rs.
4,00,000
Direct Wages
Rs.
2,24,000
Rs.
96,000
Rs.
7,20,000
It is further ascertained that :

a.
Direct Materials in type P cost twice as much direct materials in type Q.
b.
Direct wages for type Q were 60% of those for type P.
c.
Production overheads were of same rate for both types.
Elements of Costs
171
d.
Administration overhead for each was 200% of direct labour.
e.
Selling costs were 50 paise per pen for both types.
f.
Production during the year
g.
h.
Type P
40,000
units
Type Q
1,20,000
units
Type P
36,000
units
Type Q
1,00,000
units
Sales during the year
Selling prices were Rs. 14 per pen for type P and Rs. 10 per pen for type Q.
Prepare a statement showing per unit cost of production, profit and total sales value and profit
separately for two types of pens P and Q.
Solution :
Cost Statement for the year ended on 30th September, 1990
Particulars
1,60,000
2,40,000
Direct Wages
80,000
1,44,000
24,000
72,000
1,60,000
2,88,000
a.
Cost of Production
4,24,000
7,44,000
b.
Production (Units)
40,000
1,20,000
c.
Per Unit Cost of Production (Rs.)

(Being a/b)
10.60
6.20
d.
Sales (Units)
36,000
1,00,000
e.
Cost of Sales
(Being d x c)
3,81,600
6,20,000
f.
Selling Cost
18,000
50,000
g.
Total Cost
(Being e + f)
3,99,600
6,70,000
h.
Per Unit Selling Price (Rs.)
14.00
10.00
i.
Sales
(Being d x f)
5,04,000
10,00,000
j.
Profit
1,04,400
3,30,000
Direct Material
172
Working Notes :
a.
Direct Materials
Let per unit direct materials cost of Q be Rs. X. Hence, per unit direct materials cost of
P will be 2X Total Direct Materials Cost will be 40,000 units x 2X + 1,20,000 units x X
= 4,00,000.
Solving for X, we get X = Rs. 2
Hence, Direct Materials Cost for P will be Rs. 1,60,000 and Direct Materials Cost for Q
will be Rs. 2,40,000.
b.
Direct Wages
Let rate of labour be Rs. X for P Hence, rate of labour for Q will be 0.6X for Q
Total Direct Wages will be 40,000 units x X + 1,20,000 units x 0.6X = 2,24,000
Solving for X, we get X = 2
Hence, Direct Wages Cost for P will be Rs. 80,000 and Direct Wages Cost for Q will be
Rs. 1,44,000.
(9)
A company presently sells an equipment for Rs. 35,000. Increase in prices of labour and
material are anticipated to the extent of 15% and 10% respectively in the forthcoming
year. Material cost represents 40% of cost of sales and labour cost 30% of cost of sales.
The remaining relate to overheads. If the existing selling price is retained, despite the
increase in labour and material prices, the company would face a 20% decrease in the
existing amount of profit on the equipment.
You are required to arrive at a selling price so as to give the same percentage of profit on
increased cost of sales, as before. Prepare a statement of profit/loss per unit showing the new
selling price and cost per unit in support of your answer.
Solution :
Let cost of sales per unit be Rs. X. Then per unit profit will be 35000 X.
Per unit cost structure will be as below
Material Cost
0.4X
Labour Cost
0.3X
Overheads
0.3X
After the price increase, per unit cost structures will change as below
Material Cost
0.44X
Labour Cost
0.345X
Overheads
0.3X
Elements of Costs
173
However, after the price increase and existing selling price remaining the same, the profit per
unit will come down by 20%.
Hence, the following equation will emerge
35,000 (0.44X + 0.345X + 0.3X) = 0.8 (35,000 X)
Solving for X, we get X = 24,561. Hence, the existing per unit cost of sales is Rs. 24,561.
As such, following is the per unit cost structure with the existing prices and after the price
increase,
Existing
Future
Materials Cost
9,825
10,808
Labour Cost
7,368
8,473
Overheads
7,368
7,368
Cost of Sales
24,561
26,649
Profit
10,439
8,351
Selling Price
35,000
35,000
Existing profit on cost of sales works out as

10,439
X 100 = 42.5%
24,561
If the same profit percentage is to be maintained after the cost increase, the new selling price
will be
26,649 + 42.5% of 26,649 = Rs. 37,975.
(10) A firm has purchased a plant for manufacturing a new product, the cost data for which is
given below.
Estimated Annual Sales
24,000 units.
Estimated Costs
Material
Rs. 4.00 per unit
Direct Labour
Rs. 0.60 per unit.
Overheads
Rs. 24,000 per year.
Rs. 28,800 per year.
Selling Expenses
15% of sales.
Calculate the selling price if profit per unit is Rs. 1.02.

174
Solution :
Let the selling price be Rs. X
Hence, total sales will be Rs. 24000X
The cost sheet will be as below
Material Cost
24000 x Rs. 4.00
96,000
Direct Labour
24000 x Rs. 0.60
14,400
Overheads
24,000
28,800
Selling Expenses 15% of sales
3,600X
Profit
24,480
Re. 1.02 per unit
Hence,
24000X = 96000 + 14400 + 24000 + 28800 + 3600X + 24480
24000X = 187680 + 3600X
20400X = 187680
X = 9.20
Hence, selling price will be Rs. 9.20
QUESTIONS
1.
What do you mean by Elements of Cost? Explain in details. Draw a standard format of
cost sheet for a machine tool manufacturing company. Assume suitable data.
2.
How the cost is classified into various elements for presenting the same in the form of a
cost sheet. Prepare a standard format of cost sheet for a furniture making unit. Assume
suitable data.
Elements of Costs
175
PROBLEMS
(1)
The following figures relates to the trading activities of Hind Traders for the year ended
30.6.79. Prepare a statement showing net operating income.
Rs.
(2)
Rs.
Sales
5,20,000
Office Salaries
27,000
Purchases
3,22,250
Rent
2,700
Opening Stock
76,250
Stationery & Postage
2,500
Closing Stock
98,500
Depreciation
9,300
Sales Returns
20,000
Other charges
16,500
Interest on Debentures
15,300
Provision for Tax
40,000
Advertising
4,700
Travelling
2,000
From the following list of balances, prepare a statement showing net operating income.
Rs.
Sales
5,40,000
Purchases
1,60,000
Sales Returns
40,000
Purchases Returns
10,000
Opening Stock
50,000
Closing Stock
60,000
Rent Received
1,50,000
Profit on sale of asset
1,00,000
Office Expenses
25,000
Manufacturing Expenses
30,000
Selling Expenses
10,000
Depreciation
13,000
Interest on Loan
Income Tax
176
2,000
150
(3)
A Ltd. is a company which is engaged in the business of executing the various jobs as
per the customer requirements. It has received one job from one of the customers for
which it is required to submit the quotation. The Production Manager of the company
has worked out the following details of the cost in respect of the said job
Raw Materials
Rs. 40,000
Bought Out Components
Rs. 50,000
Primary Packing Material
Rs. 5,000
Consumable Stores
Rs. 4,000
Direct Workers
400 Labour Hours @ Rs. 30 per hour
Royalty Payable
20% of Direct Material
Other Factory Overheads
15% of Prime Cost
Support from administrative staff
100 Man-hours @ Rs. 50 per hour
Other administration overheads
15% of Factory Cost
Selling Overheads
10% of Total Cost
What selling price should be quoted by the Company if it intends to earn a profit of 20% on
selling price?
(4)
Honesty Engineering Works has a machining shop in which it manufactures two Auto
Parts P1 and P2 out of forgings F1 and F2. For the quarter ending December 1993,
following cost data are available
Consumption of Raw Materials - F1
1,50,000
- F2
2,00,000
Wages and Salaries
1,53,000
Stores and Spares
12,000
Repairs and Maintenance
15,000
Power
16,000
Insurance
8,000
Depreciation
50,000
Factory Overheads
68,000
64,400
Distribution Overheads
75,000
Total Cost
Elements of Costs
8,11,400
177
You are given further information

a.
Production and Sales of P1 and P2 were as under P1
P2
6,000
4,000
4,80,000
5,20,000
Production (Pieces)
Sale of above pieces (Rs.)
b.
Direct wages paid were Rs. 36,000 incase of P1 and Rs. 32,000 for P2. This is used for
apportioning Wages and Salaries and Factory Overheads.
c.
Following machine hours were utilized in production of these products

P1 550
P2 450
d.
Stores & Spares, Repairs & Maintenance, Power, Insurance and Depreciation are charged
to cost of both the products on the basis of machine hours used.
e.
Administration Ovcrheads are apportioned on the basis of respective conversion costs

while Distribution Overheads on the basis of their sales realizations.
f.
All the production was sold out.
Required Prepare cost sheets of both the products and work out profit earned of each of
them.
(5)
The cost of manufacturing 5,000 units of a commodity comprises Material Rs. 20,000,
Wages Rs. 25,000, Chargeable Expenses Rs. 400. Fixed Overheads Rs. 16,000, Variable
Overheads Rs. 4,000.
For manufacturing every 1,000 extra units of the commodity, the cost of production
increases as follows.
1.
Materials : Proportionately.
2.
Wages : 10% less than proportionately.
3.
Chargeable Expenses : No extra cost.
4.
Fixed Overheads : Rs. 200 extra.
5.
Variable Overheads : 25% less than proportionately.
Calculate the estimated cost of producing 8,000 units of the commodity and show by
how much it would differ if a flat rate of factory overhead were charged.
(6)
178
The following is the profit and loss account of a manufacturing company for the year
1987-88 (figures in lakhs).
Rs.
Rs.
Materials
48
Sales
Wages
36
Closing Stock of
Factory overheads
24
finished goods
Gross Profit c/d
12
Work in Progress (at cost)
Goodwill and Preliminary

Expenses written at
Net Profit
18
Materials
3.00
Labour
1.80
Works Expenses
1.20
120
Administration Expenses
96
6
120
Gross Profit b/d
12
Interest Received
13
13
During the year 6000 units were manufactured and 4800 units were sold. The costing records
show that works expenses have been charged @ Rs. 300 per article,and administration
expenses @ Rs. 150 per article. The costing books show a profit of Rs. 12 lakhs.
Prepare cost sheet and show the reconciliation
(7)
A firm manufactured and sold 500 units during the year ended on 31st March, 2001. The
summarised Trading and Profit & Loss Account is as below :
Particulars
Rs.
Material Consumed
40,000
Direct Labour
60,000
Manufacturing Cost
25,000
Gross Profit
75,000
Particulars
Sales
2,00,000
Management Expenses
Rent
30,000
2,00,000
2,00,000
Gross Profit
75,000
5,000
General Expenses
10,000
Selling Expenses
15,000
Net Profit
15,000
75,000
Elements of Costs
Rs.
75,000
179
For the year 2001-2002, the estimates are :

a.
Output and sales will be 600 units.
b.
Material prices will increase by 20% over the previous year.
c.
Direct Labour rate will rise by 5%.
d.
Manufacturing expenses will increase in proportion to prime cost.
e.
There will be no change in selling expenses per unit.
f.
Rise in output will not affect other expenses.
Prepare a statement showing the price in such a way that profit will be 20% on selling price.
(8)
Following costs were incurred in producing 800 MT of M.S. Rods

Materials
2,80,000
Labour
1,00,000
Processing Charges
1,00,000
Total Cost
4,80,000
Of the total output, 10% was defective and had to be sold after a discount of 10% off the
normal price. The scrap arising out of the production realized a sum of Rs. 8,760. The sale
price is calculated to yield 15% profit on sales. You are required to find out the normal price as
well as the discounted price of per MT of M.S. Rods.
(9)
In a factory, the methods mentioned below are adopted for the allocation of office and
selling overheads.
(a)
Advertisement and Sales Promotion - On Factory Cost figures.
(b)
Credit and Collection Expenses - On Sales figures.
(c)
Direct Selling Costs - On Sales figures.
(d)
Other items - On Factory Cost figures.
The factory deals with five different types of products viz. B, C, D, E and F. The following
information has been collected from its books.
180
Particulars
Rs.
Rs.
Rs.
Rs.
Rs.
Direct Materials
24,000
48,000
66,000
33,000
40,500
Direct Wages
27,000
36,000
57,000
24,000
34,500
1,12,500
1,65,000
2,62,500
1,09,500
1,60,500
Sales
Factory overhead charges are 80% of direct wages. Office and sales expenses are :
Rs.
Direct Selling Costs
81,000
Other Items
53,280
Credit and Collection Expenses

Advertisement and Sales Promotion
8,100
79,920
Prepare a statement showing the costs incurred and the profit earned in respect of each
product. (Calculations may be made to the nearest rupee).
Elements of Costs
181
NOTES
182
Chapter 8
MATERIAL COST
Material cost is the first and probably the most important element of cost. In case of some
specific types of industries, say cement, sugar, chemicals, iron and steel etc., the materials
cost forms a very significant portion of the overall cost of production.
The term material refers to all commodities which are consumed in the production process.
The materials which can be consumed in the production process can be basically classified
as:
(i)
Direct Materials
(ii)
Indirect Materials
The meaning of both these terms has already been discussed. The basic objective of cost
accounting i.e. ascertainment of cost and control of cost is equally applicable to material cost
as well. The ascertainment of material cost is made from basically two documents i.e. the
invoice of the supplier of material and material requisition slip specifying material issued from
stores department to production department. However, a whole lot of organisational procedures
are also involved in the process, which affect the material cost, either directly or indirectly.
E.g. Purchases from improper source of supply may be expensive, non-availability of material
in time may result into hold ups and so on. As such, a proper study of the various procedures
involved in case of the movement of materials and a proper control thereon enables an
organisation to exercise the control on a sizeable manufacturing cost.
The movement of material may involve the following stages.
(a)
Procurement of materials.
(b)
Storing the material till it is required for consumption.
(c)
Issue of the material for consumption.
(A) Procurement of Materials : Though the practices may differ from organisation to
organisation, normally, the process of purchasing the materials involves the following
stages.
Material Cost
183
(1)
Purchase Requisition : It is an indication given to the purchases department to

purchase certain material. It is issued either by storekeeper (in respect of material
required for regular production purposes) or by production department (in respect of
special materials required). Following particulars must appear in purchase requisition.
(i)
Material to be purchased : It should be clearly specified. To make it more

specific, in addition to the description of the material required, code number
should also be specified.
(ii)
When it is required : Unless the material is required for regular production

purposes (when the storekeeper himself will place the purchase requisition as
soon as it reaches the ordering level), purchase requisition should mention
the last date by which the material is required. Ideally, the material should be
purchased whenever the market for the same is favourable.
(iii) How much to be purchased : Purchase requisition should state the quantity
of the material required. Before deciding the quantity of material to be
purchased, the principle which should be kept in mind is that there should not
be any overstocking or understocking of materials as both these situations
involve costs.
Overstocking may have following consequences :
- Blocking of working capital.
- Risk of deterioration of quality and obsolescence.
- More storage facilities.
- Additional Insurance Cost.
- More material handling and upkeeping.
- Risk of breakage/pilferage etc.
Understocking may have following consequences :
- Production hold ups, resulting into disturbed delivery schedules.
- Frantic eleventh hour purchases which may result into unfavourable prices
and quality.
- Payment for idle time to workers.
Before deciding the quantity to be purchased, consideration will have to be
given to the following factors also :
(i) Quantity already ordered.
184
(ii) Quantity reserved. There may be the case that a particular quantity, though
in hand, might have been reserved for a particular job which is not available
for other purposes. In such cases, this quantity is such, as if it is not in
stock.
(iii) Funds availability - Amounts which are kept aside for drawing up purchase
budget should be considered.
The purchase requisition should be signed by Head of the Department drawing the same.
A standard form of Purchase Requisition is as shown below :
PURCHASE REQUISITION
To : Purchase Department
From : Department
No.
Date
Please purchase the material stated below.

Sr. No.
Description
Code No.
Signed by : Storekeeper
Quantity Required
Quantity on hand
Remarks
Approved by
For the use of Purchase Department only

Date
P.O. No.
Name of Supplier
Delivery Date
Remarks
Signed : Purchase Manager
(2)
Selection of Source of Supply :

For this purpose, the purchase department may call for the quotations from the prospective
suppliers of a certain type of material. In practice, following types of quotations may be
called for :
(a)
Single Tender : It is addressed to only one selected source when there is only
one source of supply available.
Material Cost
185
(b)
Limited Tender : It is addressed to a limited number of suppliers known to be

reliable sources on the basis of data maintained by the purchase department.
(c)
Open Tender : It is open to all who can supply specified quality and quantity of the
required material. Tenders are called by giving advertisements in the newspapers,
journals etc.
(d)
Global Tender : Anybody from any part of the world can respond to these tenders.
To discourage unreliable and unwanted sources from quoting, some tender deposit may be
insisted upon.
Comparative Statements :
After receiving the tenders as stated above, a comparison has to be made among the various
available sources so that the best possible source can be selected. All the offers are tabulated
in a comparative statement. The authority which is authorised to accept the tender should be
specified. The criteria for selecting the final source of supply may depend upon the terms of
offer which can be compared in respect of price offered, quality, other terms (like Sales Tax,
Octroi, Freight etc.), terms of delivery, terms of payment, guarantee offered by the supplier,
goodwill of the supplier etc. Lowest quotation may not necessarily be the best quotation.
(3)
Purchase Order :
The contractual obligation between the supplier and purchaser starts from purchase
order. It is drawn in favour of the supplier by the purchase department. It may specify a
number of facts.
186
Material to be supplied (Description as well as code numbers and quality).
Quantity to be supplied.
Price and other terms (e.g. excise duty, sales tax, octroi, insurance, packing and
transportation etc.).
Cash and trade discount.
Instructions in respect of delivery.
Guarantee clause.
Liquidated damages clause.
Escalation clause.
Inspection clause.
Method of settlement of disputes.
Details in respect of letters of credit, import licence etc.
Details in respect of interest payable in the event of late payment of dues.
Ideally, purchase orders should be serially numbered. Normally, four or five copies of
Purchase Orders are drawn, to be distributed as below :
-
One to Supplier.
One to User Department.
One to Stores Department.
One to Accounts/Costing Department.
One with Purchase Department.
A standard form of Purchase Order is as shown below :

PURCHASE ORDER
No.
Date
Requisition No.
Date
Please supply the following material on such terms and conditions as stated therein.
Description
Code No.
Quantity
Rate Rs.
Value Rs.
Delivery Date
Remarks
Delivery : Goods to be delivered at

Extra as applicable
Excise Duty
Sales Tax
Packing Charges
Insurance
Terms of payment
For (Purchasing Company)
Purchase Manager
Material Cost
187
(4)
(5)
Receipt and Inspection : After material is received from the supplier, the quantity
received actually, is compared with quantity ordered. Variations, if any, are taken up with
the supplier again. Excess material received may be dealt with in any of the following
ways :
Accept all the material received.
Accept the material ordered and return the excess to the supplier.Before accepting,
material may be subjected to inspection. The extent of inspection may vary from
material to material.
Checking invoice and accounting for purchases : The suppliers invoice received for
the supply of material is subjected to scrutiny before a voucher is passed for the same
for making the entry in the books of accounts. For this purpose, the suppliers invoice
may be compared alongwith the following documents.
(a)
Purchase Order.
(b)
Goods Received Note.
(c)
Inspection Report.
If the quantity and/or rate as per purchase order and invoice match with each other, the
invoice of the supplier is passed for making the entry in the books of accounts. If the
quantity and/or rate as per purchase order and invoice differ from each other, the difference
is adjusted by raising a debit or credit note in favour of the supplier.
(B) Storing and Issue of Material : After the material is received, inspected and approved,
the process of storing comes into operation which deals with storing the material in good
condition till it is required for use by production departments and issuing the same
whenever required.
As far as the movement of the material from the stores point of view is concerned, there
can be basically four types of movements.
188
(1)
Receipt of material.
(2)
Issue of material
(3)
Return of material from Production Department to Stores Department.
(4)
Transfer of material.
(1)
Receipt of Material :Usually the receipt of material is accompanied by delivery

challan given by the supplier. On receipt of the material, quantity received is checked
with the quantity ordered by the Stores Department. The received material may be
inspected, before acceptance either by separate inspection department or by Stores
Department itself. A document known as Goods Received Note or Goods Received

Report (GRN or GRR) is prepared to record the details of the material received. The
usual form in which GRN or GRR is prepared is as below :
GOODS RECEIVED NOTE
No.
Date
S. No.
Description
Prepared by
Code
Qty. Recd.
Received by
Qty. Accepted
Inspected by
Qty. Rejected
Remarks
Store Keeper
It may be prepared in quadruplicate to be distributed as follows.
One copy to Purchases Department for comparing with purchases order and approving
the invoice of the supplier.
One copy to Accounts Department for making the payment of suppliers invoice.
One copy to Costing Department for pricing and entering in stores record.
One copy to be retained by Stores Department.
Ideally, GRN/GRR should be serially numbered in order to locate the material which is physically
received but for which invoice is not received.
Discrepancies in material receipts :
The material physically received when compared with material ordered as per the purchase
order may reveal certain discrepancies which may take any of the following forms.
(1)
Quantity received in excess.
(2)
Quantity received in short.
(3)
Quantity received of different quality.
Excess quantity received may be retained and accepted, if required, with the approval of the
purchase department. Alternatively, if it is not accepted, it may be returned to the supplier with
Goods Returned Note. The usual form in which Goods Returned Note is prepared is as below:
Material Cost
189
GOODS RETURNED NOTE

To :
No.
Date :
Following material supplied by you vide your D.C. No.____________ and Invoice
No.____________against our Purchase Order No. ______________is being returned to
you for the reasons stated below:
Description
Quantity
Reasons
Signature
Usually, three copies of Goods Returned Note are prepared to be distributed as below :
-
One copy to the Supplier.
One copy to the Purchase Department.
One copy to be retained by the Stores Department.
Excess Quantity Accepted : If excess quantity is already billed in the invoice, it will be
approved and paid. If not, either the supplier may be asked to give a supplementary invoice or
credit note may be issued to the supplier for amending the amount.
Excess Quantity Returned : If excess quantity is already billed in the invoice, debit note may
be issued to the supplier for amending the amount.
In case the quantity received is short, purchase department may take up the case with the
supplier or carrier or insurer as per the terms of purchases. If quantity short supplied is billed
in the invoice, invoice is suitably amended and debit note is issued to the supplier.
If quantity received is of different quality and is rejected in inspection, it can either be retained
or returned. It may be retained by accepting some mutually decided concessional price. The
variation in prices may be adjusted by issuing either the credit note or debit note in favour of
the supplier.
(2)
190
Issue of Material : Here, the issue of material refers to issue of material from stores
department to production department. The material should not be issued from the stores
unless a proper authority in writing is produced before the stores department. Usually,
this authority is in the form of Material Requisition Note or Material Requisition Slip.
The normal contents of this note/slip are :
Number and date (Ideally, they should be serially numbered).
Department demanding the material.
Description and code of material demanded.
Quantity of material demanded.
Signature of authority approving the demand.
Signature of the person receiving the material.
Normally one note/slip is prepared for requisitioning a single item of material.

The usual form in which it is prepared is as below :
MATERIAL REQUISITION NOTE
Production/Job Order No.
No.
Bill of Materials No.
Date :
Department :
Description
Code
Authorised
by
Issued
by
Qty.
Unit
Cost (for costing Dept. only)

Rate per unit
Amount Rs.
Received
by
Entered and Valued

by
Normally, it is prepared in three copies.Two copies to Stores Department which in its turn
passes one copy to Costing Department for pricing while second copy is retained by the
Stores Department. One copy is for demanding department.
(3)
Return of material :
There can be some situations, when material once issued to production departments is
returned back to the stores. It can happen in the following circumstances.
(a)
Material issued in excess of requirement.
(b)
Scrap or defective work arising out of the production processes.
Under these circumstances, a document in the form of Materials Returned Note is prepared,
which is to record return of unused materials. The usual form in which this document is
prepared is as below :
Material Cost
191
MATERIALS RETURNED NOTE

No.
Bill of Materials No.
Date :
Department :
Description
Code
Authorised
by
Qty.
Unit
Received
by

Rate per unit
Amount Rs.
Posted
by
As far as the valuation of the returned material is concerned, it may be treated as the fresh
receipt of the material or alternatively, it may be treated as the negative(minus) issues.
(4)
Transfer of Materials :In some situations, considering the urgency for the requirement
of the material, it may be necessary to transfer the material from one production/job
order to another. Such transfer of material is usually accompanied by preparing a document
in the form of Material Transfer Note. The usual form in which this document is prepared
is as below :
MATERIAL TRANSFER NOTE

No.
Date :
FromDept.
To..Dept.
Production/Job
Production/Job
Order No.
Order No.
Description
Authorised
by
192
Code No.
Qty.
Received
by

Rate per unit
Amount Rs.
Entered
by
Transfer of materials does not result into any fresh issue of material. However, material transfer
notes will have to be valued and considered in order to compute the material cost as per the
job orders and production orders.
PROPER CONDUCT OF STORAGE FUNCTION
As discussed earlier, proper conduct of storage function requires that material should be
properly stored in good condition till it is required for use by production departments and
should be issued whenever required. This proper conduct is ensured by what is known as
Perpetual Inventory System. The aims of the perpetual inventory system are two fold.
(1)
Recording receipts and issues in such a way so as to know at any time, the stock in
hand, in quantity and/or value, without the need of physical counting. This aim is achieved
by maintaining what is called as Bin Card and Stores Ledger.
(2)
Continuous verification of physical stock at regular intervals.
Bin Card
It is only a quantitative record of receipts, issues and closing balance of an item of material.
Separate bin card is maintained for each item of material. The usual form in which a bin card
is maintained is as below.
BIN CARD
Description
Maximum level
Code No.
Minimum level
Location/Unit
Recorder level
Date
Document No.
Receipt
Issue
Balance
Remarks
Entries in receipts column are made on the basis of Goods Received Note or Material Returned
Note. Entries in issues column are made on the basis of Material Requisition Note. After every
entry of either receipts or issues, the balance quantity is calculated and recorded so that the
balance can be known at any point of time. The levels indicated on bin card enable the stores
department to keep a watch on balance and replace the material as soon as it reaches the
reorder level.
Material Cost
193
Ideally, bin card should be placed alongwith the material. But it may not be possible in all the
cases, then bin cards are placed at a centrally located place but within stores department
only.
Stores Ledger
Like Bin Card, it is maintained to record all receipts and issue transactions of material but with
the exception that it records not only the quantities received or issued or in stock but also the
financial expressions of the same. The usual form in which the stores ledger is maintained is
as following :
STORES LEDGER
Description
Maximum level
Code No.
Minimum level
Location/Unit
Recorder level
Date
Document No.
Receipts
Qty. Rate Rs.
Issues
Balance
Qty. Rate Rs. Qty. Rate
Remark
Rs.
By summing up the amounts appearing in the issues column of stores ledger, one can get
the cost of material issued to Production Department which forms the Material Cost.
As in case of bin card, separate store ledger sheets are maintained in case of each item of
material. The stores ledger sheets are maintained either in loose form or in bound book form.
Bin Card Vs. Stores Ledger :
If the stores ledger is having all the information mentioned in a bin card plus some additional
information is also available, the next question which arises is why is it necessary to maintain
both bin card and stores ledger simultaneously as it will be only duplication of work. In the
situations of computerized inventory accounting system, maintenance of bin card and sotres
ledger simultaneously can be avoided. However, in the situations of manual inventory accounting
system, it will be ideal to maintain bin card and stores ledger simultaneously due to the
following reasons.
(1)
194
Bin card is maintained by stores department while stores ledger is maintained by costing
department.
(2)
Bin card is not an accounting record but only a quantity record and as such is not
concerned with the financial implications of stores transactions.
(3)
Maintenance of stores ledger provides a second check on maintenance of bin cards.
Reconciliation of Bin Card and Stores Ledger :

As the source documents for the entries in Bin Card and Stores Ledger are the same, the
closing balances disclosed by both of them should match with each other. But in practice,
they may not match due to the following reasons.
(1)
Arithmetical error in calculating balance.
(2)
Non-posting of certain document in either of these documents.
(3)
Posting on wrong bin card or stores ledger sheet.
(4)
Treating receipts transaction as issue transaction or vice versa.
If the closing balance as per bin card and stores ledger is not matching, the very purpose of
maintaining these two documents simultaneously will be defeated. As such, it is necessary
to reconcile both balances at regular intervals by keeping all the postings upto date. If the
balances as on a particular day are not matching, all the previous transactions should be
checked to locate differences.
Valuation of Material Movements :
As discussed above, the stores ledger considers not only the movement of material in terms
of quantity but also in terms of its financial implications. As such, it is necessary that all the
possible movements of material are valued properly and are expressed in terms of money. We
will consider this problem under the following heads.
(a)
Valuation of receipts.
(b)
Valuation of issues.
(c)
Valuation of returns from production department to stores department.
(a)
Valuation of receipts :
Valuation of receipts is relatively an easy task, as the invoice or bill received from the
supplier of the material is available as a starting point. Following propositions should be
considered for this purpose.
(1)
The price as billed by the supplier will be the valuation of the receipts. The trade
discount is deducted from the basic price and all other amounts as billed by the
supplier are added viz. Excise Duty, Sales Tax, Octroi Duty, Transport/Insurance
charges etc. There are different opinions in respect of the treatment of cash discount.
One opinion says that cash discount should be ignored being purely of financial
nature while valuing the receipts, while another opinion says that it should be
considered while valuing the receipt of the material.
Material Cost
195
(2)
In some cases, more than one item of material are included in one single bill and
some costs are jointly incurred for all the items of material. Such joint costs may
be distributed on the basis of basic price of the material.
(3)
In case of the imported material, the cost of the material consists of basic price
(which may be stated in foreign currency and should be converted in Indian Rupees),
Customs Duty, Clearing Charges, Transport Charges, Octroi Duty etc. In some
cases, the point of receipt of imported material and the point of making the payment
of invoice amount may be different. As such, rate of foreign currency may be different
at the time of payment of customs duty and at the time of payment of invoice
amount. In such cases, the rate of exchange existing at the time of making the
payment of invoice amount should be considered for valuing basic cost of material
imported.
Illustration :
The particulars relating to 1,200 kgs. of a certain raw material purchased by a company during
June, were as below.
(a)
Lot prices quoted by suppliers and accepted by the company for placing the purchase
order.
Lot upto 1000 kgs.
@ Rs. 22 per kg.
Between 1000 - 1500 kgs.
@ Rs. 20 per kg.
Between 1500 - 2000 kgs
@ Rs. 18 per kg.
(b)
Trade Discount 20%.
(c)
Additional charge for containers @ Rs. 10 per drum of 25 kgs.
(d)
Credit allowed on return of containers @ Rs. 8 per drum.
(e)
Sales Tax at 10% on raw material and 5% on drums.
(f)
Total freight paid by the purchaser Rs. 240,
(g)
Insurance at 2.5% (on net invoice value) paid by the purchaser.
(h)
Stores Overheads applied at 5% on total purchase cost of material.
For
Supplies
to Factory
The entire quantity was received and issued to production :

The containers are returned .in due course. Draw up a suitable statement to show :
196
(a)
Total cost of material purchased.
(b)
Unit cost of material issued to production.
Solution :
(a)
Statement showing cost of purchases

Basic Cost
Rs.
1,200 kgs x Rs. 20/kg.
Rs.
24,000
Less : Trade Discount @ 20%
4,800
19,200.00
Container Cost :
48 Drums x Rs. 10 /Drum
480.00
19,680.00
Sales Tax :
10% on Rs. 19,200
1,920.00
5% on Rs. 480
24.00
1,944.00
21,624.00
Other charges
Insurance 2.5% on Rs. 21,624.00
540.60
Freight
240.00
22,404.60
Less : Credit for drums returned

Rs. 8 per Drum x 48 Drums
TOTAL COST
384.00
22,020.60
Add : Stores Overheads 5%
1,101.03
23,121,63
(b)
Unit cost for valuation of issues

Rs. 23,121.63.
1,200 kgs.
= Rs. 19.268/kg.
Illustration :
The particulars related to the import of Sealing Ring made by AB & Co. during December 85
are given below.
(a)
Sealing Ring 1,000 pieces invoiced @ 2 CIF, Bombay Port.
(b)
Customs Duty was paid @ 100% on invoice value (which was converted to Indian Currency
by adopting an Exchange Rate of Rs. 17.20 per )
Material Cost
197
(c)
Clearing charges : Rs. 1,800 for the entire consignment
(d)
Freight charges : Rs. 1,400 for transporting the consignments from Bombay Port to
Factory premises.
It was found on inspection that 100 pieces of the above material were broken and therefore
rejected. There is no scrap value for the rejected part. No refund of the broken material would
be admissible as per the terms of contract. The management decided to treat 60 pieces as
normal loss and the rest 40 pieces as abnormal loss. The entire quantity of 900 pieces was
issued to production.
Calculate :
(a)
Total cost of material.
(b)
Unit cost of material issued to production.
Also state briefly how the value of 100 pieces rejected in inspection will be treated in costs.
Solution :
Total Cost of Material
(1)
Invoice Price
Rs.
UK - 1,000 pieces x 2 = 2,000

- 2,000 x Rs. 17.2 per UK
34,400
(2)
Customs Duty @ 100%
34,400
(3)
Clearing Charges
1,800
(4)
Freight charges
1,400
Total Cost
72,000
As loss of 40 pieces is considered as abnormal loss, it will be transferred to Costing Profit and
Loss Account.
Abnormal Loss =
Rs. 72,000
1,000 pieces
X 40 pieces
= Rs. 2,880
Balance of the cost (i.e. Rs. 72,000 - Rs. 2,880 = Rs. 69,120)Includes cost of units treated as
normal loss i.e. 60 pieces.
This cost will be borne by good pieces.
198
Rs. 69,120
Unit cost of good pieces
=
900 pieces
=
(b)
Rs. 76.80
Valuation of Issues :
This is a more complex process than the valuation of the receipts. It is because of the
reason that the material may be issued out of the various lots which might have been
purchased at various prices. As such, a problem may arise as to which of the receipt
prices should be used to value the material requisition notes. Various methods may be
used for this purpose, main methods of which may be discussed as below.
(a)
First In First Out (FIFO)Under this method, the price of the earliest available lot is
considered first and if that lot is exhausted, the price of the next available lot is
considered. It should be remembered that the physical issue of the material may
not be made out of the said lots, though it is presumed that it is made out of these
lots as stated above.
Illustration :
Following transactions have taken place in respect of a material during March 1990.
Date :
1
Opening Balance 500 units @ Rs. 6 per unit.
Purchased 100 units @ Rs. 7 per unit.
Issued 400 units.
19
Issued 250 units.
22
Issued 50 units.
25
Purchased 300 units @ Rs. 7.50 per unit.
30
Issued 250 units.
Prepare the Stores Ledger assuming that the issues are valued on FIFO basis.
Material Cost
199
Stores Ledger
Description/Code No.
Maximum level
Unit
Minimum level
Location
Re-order level
Date
Particulars
RECEIPTS
Qty.
Op. Bal.
GRN No.
Rate
Rs.
Rs.
ISSUES
Qty.
Rate
Rs.
BALANCE
Rs. Qty.
500
100
700
500
100
MRN No.
400
2,400 100
100
GRN No.
300
2,400
100
100
300
100
19
MRN No.
100
50
22
MRN No.
25
GRN No.
50
300
7.5
MRN No.
7
8
50
3,700
1300
3700
1700 250
2,000
400 200
1,600
200
}
}
3,000
2,250
200
Rs.
300
30
Rate
Rs.
8
7.5
3850
7.5
1,875
8
7.5
1975 250
Value of closing stock is Rs. 1,875 which considers latest available market price of the material.
The advantages of this method are as below :
200
(a)
It is simple to operate.
(b)
It considers the valuation of closing stock at the current market prices.
(c)
It can be conveniently applied if transactions are not too many and the prices of the
material are fairly steady.
The objections raised against this method are as below :

(a)
Calculations become complicated if the lots are received frequently and at varying prices.
(b)
Costs may be wrongly presented if the price of different lots of material are used for
pricing issues to various batches of production.
(c)
In case of varying prices, the pricing of issues does not consider current market prices.
(b)
Last In First Out (LIFO) :

Under this method, the price of the latest available lot is considered first and if that lot is
exhausted, the price of the lot prior to that is considered. Here also, it should be
remembered, that the physical issue of the material may not be made out of the said
lots, though it is presumed that it is made out of the lots as stated above.
Illustration :
Date:
1
Opening Balance 500 units @ Rs. 6 per unit.
Issued 400 units.
19
Issued 250 units.
22
Issued 50 units.
25
30
Issued 250 units.
Prepare the stores ledger assuming that the issues are valued on LIFO basis.
Material Cost
201
Stores Ledger
Maximum level
Unit
Minimum level
Location
Re-order level
Date
Particulars
RECEIPTS
Qty.
Op. Bal.
GRN No.
100
Rate
Rs.
Rs.
ISSUES
Qty.
Rate
Rs.
700
BALANCE
Rs. Qty.
MRN No.
100
300
GRN No.
300
3,000
500
} }
3,700
1,200
2,500 200
2,400
MRN No.
200
250
2,000 200
50
22
MRN No.
25
GRN No.
50
300
7.5
MRN No.
2,250
400 200
200
250
7.5
1,875 200
50
} }
} }
6
3,600
8
6
1,600
300
30
300
19
Rs.
500
100
7
Rate
Rs.
1,200
} }
} }
3,450
7.5
6
1,575
7.5
Value of closing stock is Rs. 1,575 which consists of 200 units valued at Rs. 6 per unit which
happens to be the earliest available price of the material i.e. price of the opening balance
available.
The advantages of this method are as below :
202
(a)
It is simple to operate.
(b)
The cost of materials issued considers fairly recent and current prices. The prices quoted
on this cost fairly represent its real cost.
(c)
It can be conveniently applied if transactions are not too many and prices of the material
are fairly steady.
The objections raised against this method are as below :

(a)
Calculations become complicated if the lots are received frequently and at varying prices.
(b)
Costs may be wrongly presented if the price of different lots of material are used for
pricing issues to various batches of production.
(c)
In case of falling prices in the market, this method may give wrong results.
(C) Average Price Method :

Both the above methods i.e. FIFO and LIFO, consider the exact or actual cost for valuing
the issue of material. However these methods may prove to be disadvantageous if the
transactions are too many and are at varying prices. In such cases, instead of considering
the exact or actual cost, average cost may be considered to lessen the effect of variation
in prices, either upward or downward.
E.g. Assume a situation as below :
Mar. 1
Received
1500 units @ Rs. 10
- Rs. 15,000
Mar. 15
Received
1600 units @ Rs. 30
- Rs. 48,000
On March 20, 1800 units were issued to production.

If FIFO method is followed to price the issues, the issues will be valued as below.
1500 units @ Rs. 10 per unit
Rs. 15,000
Rs. 9,000
Rs. 24,000
The issues will be considerably under-valued and closing stock will be considerably over
valued, as compared to the current market prices.
If LIFO method is followed to price the issues, the issues will be valued as below.
1600 unite @ Rs. 30 per unit
Rs. 48,000
Rs. 2,000
Rs. 50,000
The closing stock will be considerably under valued as compared to the current prices.
To lessen the effect of such drastic price variation, both on the valuation of issues as well
as of closing stock, instead of considering the actual/exact price of Rs. 10 per unit or
Rs. 30 per unit, average price may be taken into consideration.
There are mainly two ways in which average prices may be considered.
Material Cost
203
(1)
Simple Average Method :Under this method, the simple average of the prices of the
lots available for making the issues is considered for pricing the issues. After the receipt
of new lot, a new average price is worked out. It should be remembered in this connection
that, for deciding the possible lots out of which the issues could have been made, the
method of First In First Out is followed.
Illustration :
Date :
1
Opening Balance 500 units @ Rs. 6 per unit
Issued 400 units.
19
Issued 250 units.
22
Issued 50 units.
25
30
Issued 250 units.
Prepare the stores ledger assuming that the issues are valued on Simple Average basis.
Stores Ledger
Maximum level
Unit
Minimum level
Location
Re-order level
Date
Particulars
RECEIPTS
Qty.
204
Rate
Rs.
Rs.
ISSUES
Qty.
Op. Bal.
GRN No.
MRN No.
GRN No.
19
MRN No.
250
22
MRN No.
50
25
GRN No.
30
MRN No.
Rate
Rs.
BALANCE
Rs. Qty.
500
100
700
400
300
300
7.5
Rs.
3,000
600
3,700
2,600 200
1,100
500
3,500
1,750 250
1,750
350 200
1,400
500
3,650
1,825 250
1,825
6.5
2,400
2,250
250
Rate
Rs.
7.30
This method is suitable if the material is received in uniform quantity.If the material quantity of
each lot varies widely, this method may lead to wrong results.
(2)
Weighted Average Method :As stated above, the simple average method of valuation
of issues may lead to wrong results, if the quantity of each lot of material received varies
widely. Eg. Assume the following situation.
Mar. 1 Received 100 units @ Rs. 10
Mar. 10 Received 5,000 units @ Rs. 30
Rs. 1,000
Rs. 1,50,000
Rs. 1,51.000
On March 20, 4800 units were issued to production. As both the lots are possible lots for
making the issue, the average of prices of both the lots will be taken into account if
simple average method is considered. Hence, per unit issue price will be Rs. 10 + Rs. 30
2
i.e. Rs. 20
As such, the issue quantity will be priced at : 4,800 units x Rs.20 i.e. Rs. 96,000, which
will be incorrect, as considering the quantity of issue, the price of the material received
on March 10 should get more weightage.
To overcome this drawback of simple average method, weighted average method may be
used which considers not only the price of each lot but also the quantity of the same.
Though this method involves considerable amount of clerical work, in practice, this method
proves to be very useful in the event of varying prices and quantities. In practice, the
calculation of weighted average rate proves to be very simple. The products of quantity
and price divided by the total quantity of all lots, just before the issue, gives the unit price
in respect of the subsequent issues.
Illustration :
Date :
1
Opening Balance 500 units @ Rs. 6 per unit
Issued 400 units.
19
Issued 250 units.
22
Issued 50 units.
Material Cost
205
25
30
Issued 250 units.
Prepare the Store Ledger assuming that the issues are valued on Weighted Average Basis.
Stores Ledger
Maximum level
Unit
Minimum level
Location
Re-order level
Date
Particulars
RECEIPTS
Qty.
Rate
Rs.
Rs.
ISSUES
Qty.
Rate
Rs.
BALANCE
Rs. Qty.
Rate
Rs.
Rs.
500
6.00
3,000
600
6.16
3,700
2,467 200
6.16
1,233
500
7.27
3,633
Op. Bal.
GRN No.
MRN No.
GRN No.
19
MRN No.
250
7.27
1,817 250
7.27
1,816
22
MRN No.
50
7.27
363 200
7.27
1,453
25
GRN No.
500
7.41
3,703
30
MRN No.
1,851 250
7.41
1,852
(d)
100
700
400
300
300
7.5
6.16
2,400
2,250
250
7.41
Highest In First Out :This method assumes that the stock should always be shown at
the minimum value and hence the issues should always be valued at the highest value of
receipts. E.g. Assume a situation as follows.
Mar. 1 Purchased 100 units @ Rs. 12
On March 20, 120 units are issued to production and they will be valued at Rs. 18 per
unit being the highest price. This method is not very popular. It always overvalues the
issues and undervalues the closing stock. This method may be useful in case of the
organisations dealing with monopoly products which is a rare possibility.
206
(e)
Market Price : Under this method, market price is considered to be the base for pricing
the issues. In this case, market price may be treated as latest purchase price, realisable
price or replacement price. This method is used mainly in respect of obsolete stock
items or non-moving stock items.
The defect in respect of this method is that the price concessions obtained in respect of
bulk purchases are not reflected in cost of material.
(f)
Specific Price :
If the material is purchased against a specific job or production order, the issue of material
is priced at actual purchase price.
This method can be adopted if purchase prices are fairly stable.
(g)
Standard Price :
This is the normal or ideal price which will be paid in the normal circumstances, based
on the basis of estimated market conditions, transportation costs and normal quantity of
purchases. Any issue of material will be priced at standard prices irrespective of actual
prices. This enables the simplification of accounting system with reduced clerical work
and also enables to decide the efficiency of purchase department,
(c)
Valuation of Returns :
This indicates the material returned by production departments to stores department
The way in which returned material may be valued can be as below :
(a)
At the same price at which issued :

The original price of issue will be a base for valuing the returns for which original
material requisition note will be the base.
(b)
At the current price of issues :

The method which is followed for valuing the issue on the same date is considered
for valuing the returns.
This will avoid the clerical efforts, but at the same time the track of original issue of
material cant be maintained.
Treatment of shortages :
In some cases, the physical verification of stock may reveal that the physical stock is less
than the stock as per stores ledger. For proper accounting, the shortage has to be treated as
an issue so that the book stock can be brought down to the level of physical stock. The
Material Cost
207
valuation of this shortage is done as if it is an issue of material. The treatment given to the
valuation of shortages in Cost Accounts depends upon the nature of the shortage i.e. Normal
Shortage or Abnormal Shortage.
Inventory Control :
The object of inventory control is to reduce the investment in inventory without affecting the
efficiency in the area of production and sales. It should be remembered that the object is not
only to reduce the investment in inventory. If that would have been the object, no organisation
would have maintained inventory of any kind, thereby making the investment in inventory as
Nil. However, that is not the ultimate object as it is likely to affect the production and sales
function adversely. E.g. If sufficient stock of raw material is not available, the production
activity is likely to be interrupted. If sufficient stock of finished goods is not available, it may
not be possible for the organisation to serve the customers properly and they may shift to the
competitors. The object of inventory control is to avoid the situation of over investment as well
as under investment. The level of inventories should be maintained at the optimum level.
Techniques of Inventory control
(1)
Economic Order Quantity :

It indicates that quantity which is fixed in such a way that the total variable cost of
managing the inventory can be minimised. Such cost basically consists of two parts.
First, Ordering Cost (which in turn consists the costs associated with the administrative
efforts connected with preparation of purchase requisitions, purchase enquiries,
comparative statements and handling of more number of bills and receipts) Second,
Carrying Cost i.e. the cost of carrying or holding the inventory (which in turn consists of
the cost like godown rent, handling and upkeep expenses, insurance, opportunity cost
of capital blocked i.e. interest etc.) There is a reverse relationship between these two
types of costs i.e. If the purchase quantity increases, ordering cost may get reduced but
the carrying cost increases and vice versa. A balance is to be struck between these two
factors and it is possible at Economic Order Quantity where the total variable cost of
managing the inventory is minimum.
It is possible to fix the Economic Order Quantity with the help of mathematical formula.
The following assumptions may be made for this purpose.
Let Q be Economic Order Quantity.
A be Annual Requirement of material in units.
O be cost of placing an order (which is assumed to remain constant irrespective of
size of order.)
C be cost of carrying one unit per year.
208
Now, if A is the annual requirement and Q is the size of one order, the total number of
orders will be A/Q and the total ordering cost will be - A/Q x O
Similarly, if the size of one order is Q and if it is assumed that the inventory is reduced at
a constant rate from order quantity to zero when it is repurchased, the average inventory
will be Q/2 and the cost of carrying one unit per year being C, the total carrying cost will
be Q/2 X C.
Thus, Total Cost = Ordering Cost + Carrying Cost
A
XC
The intention is that the value of Q should be such that the total cost should be minimum.
Hence, taking the first derivative of the equation with respect to Q and setting the result
to zero,
do
AO (
Q2
dq
Q
2xAXO
= O
OR
2
Where
Q = Economic Order Quantity

A = Annual Requirement in Units
O = Cost of Placing an Order
C = Cost of Carrying One Unit Per Year
Illustration :
A manufacturer uses 200 units of a component every month and he buys them entirely from
outside supplier. The order placing and receiving cost is Rs. 100 and annual carrying cost is
Rs. 12. From this set of data, calculate Economic Order Quantity.
Solution :
EOQ
=
Material Cost
2xAxO
C
2 x 2400 x 100
12
200 units
209
In some cases, the carrying cost may be expressed as an annual percentage of the unit cost
of purchases, in which case, the calculation of Economic Order Quantity takes the following
form.
EOQ
2xAxO
where
Cxi
Annual Requirement in units
O =
Cost of placing an order
Unit purchase price
Carrying cost expressed as a percentage of unit purchase price.
Illustration :
From the Following data, work out the EOQ of a particular component.
Annual Demand
: 5000 Units
Ordering Cost
: Rs. 60 per Order
Price per Unit
: Rs. 100
Inventory carrying Cost : 15% on average inventory,

Solution :
EOQ
2 x 5000 x 60
15% of 100
= 200 units
The total cost of managing inventory will be
Ordering Cost - 5000
200
Carrying Cost -
200
2
X 60 i.e. 25 X 60
Rs. 1,500
X 15% of 100
Rs. 1,500
(Based on average inventory)
Rs. 3,000
Now, the next question is whether the purchases in Economic Order Quantity really reduce
the total cost of managing inventory to the minimum, We can verify this, by trial and error
method, by considering the above results.
210
Order
Quantity
No. of
Orders
A/Q
Rs.
Ordering
Cost
A/Q x O
Rs.
Carrying
Cost
Q/2 x Ci
Rs.
Total
Cost
50
100
6,000
375
6,375
100
50
3,000
750
3,750
200
250
25
20
1,500
1,200
1,500
1,875
3,000
3,075
1,000
300
7,500
7,800
1,250
240
9,375
9,615
2,500
120
18,750
18,870
It can be observed from the above, that the order size of 200 units proves to be the most
economic one in terms of minimum total cost. If the purchases are made in any other way, the
same may not necessarily result into minimum total cost.
Illustration :
Kapil Motors purchase 9,000 motor spare parts for its annual requirements, ordering onemonth usage at a time. Each spare part costs Rs. 20. The ordering cost per order is Rs. 15
and the carrying charges are 15% of the average inventory per year. You have been asked to
suggest a more economical purchasing policy for the company. What advice would you offer
and how much would it save the company per year.
Solution :
Present Policy :
Annual Requirement
Number of Orders =
Order size
=
9000
750
Ordering Cost
Carrying Cost
12 X 15 = 180
Order Size
2
750
2
=
Total Cost i.e. 1 + 2
Material Cost
= 12
X Cost Price
X Carrying cost in %
X 15% of Rs. 20
375 X 3 = 1,125
=
...(1)
180 + 1125 = 1305
...(2)
...(3)
211
Proposed Policy :
To purchase in Economic Order Quantity
EOQ
2xAxO
Cxi
2 x 9000 x 15
15% of 20
300 units
Now, the revised total cost will be

Number of Orders
9000
300
Ordering Cost
30 x 15 = 450
...(4)
Carrying Cost
300
2
...(5)
150 X 3 = 450
450 + 450 = 900
Total Cost i.e. 4 + 5
= 30
X 15% of 20
...(6)
Thus, purchases in Economic Order Quantity will result into the yearly saving of Rs. 405 (i.e.
Rs. 1305 - Rs. 900)
(2)
Fixation of Inventory Levels :

Fixation of various inventory levels facilitates initiating of proper action in respect of the
movement of various materials in time so that the various materials may be controlled in
a proper way. However, the following propositions should be remembered.
(i)
Only the fixation of inventory levels does not facilitate the inventory control. There
has to be a constant watch on the actual stock level of various kinds of materials so
that proper action can be taken in time.
(ii)
The various levels fixed are not fixed on a permanent basis and are subject to
revision regularly.
The various levels which can be fixed are as below.

(1)
Maximum Level :
It indicates the level above which the actual stock should not exceed. If it exceeds, it
may involve unnecessary blocking of funds in inventory. While fixing this level, following
factors are considered.
212
(i)
Maximum usage.
(ii)
Lead time.
(iii) Storage facilities available, cost of storage and insurance etc.

(iv)
Prices for the material.
(v)
Availability of funds.
(vi)
Nature of material e.g. If a certain type of material is subject to Government regulations

in respect of import of goods etc., maximum level may be fixed at a higher level.
(vii) Economic Order Quantity.

(2)
Minimum Level :
It indicates the level below which the actual stock should not reduce. If it reduces, it may
involve the risk of non-availability of material whenever it is required. While fixing this
level, following factors are considered.
(3)
(i)
Lead time.
(ii)
Rate of consumption.
Re-order Level:
It indicates that level of material stock at which it is necessarily to take the steps for
procurement of further lots of material. This is the level falling in between the two extremes
of maximum level and minimum level and is fixed in such a way that the requirements of
production are met properly till the new lot of material is received.
(4)
Danger Level :
This is the level fixed below minimum level. If the stock reaches this level, it indicates the
need to take urgent action in respect of getting the supply. At this stage, the company
may not be able to make the purchases in a systematic manner but may have to make
rush purchases which may involve higher purchases cost.
Calculation of various Levels :

The various levels can be decided by using the following mathematical expressions.
(1)
Re-order Level : Maximum Lead Time x Maximum Usage.
(2)
Maximum Level : Reorder Level + Reorder Quantity - (Minimum Usage X Minimum

Lead Time).
Material Cost
213
(3)
Minimum Level : Reorder Level - (Normal Usage x Normal Lead Time.)
(4)
Average Level : Maximum Level + Minimum Level.
(5)
Danger Level : Normal Usage x Leadtime for emergency purchases.
Note : It should be noted that the expression of the Reorder Quantity in the calculation of
Maximum Level indicates Economic Order Quantity.
Illustration :
Two components X and Y are used as follows.
Normal usage
50 units per week each.
Minimum usage
Maximum usage
Reorder quantity
X - 400 units
Y - 600 units
Recorder period
X - 4 to 6 weeks
Y-2 to 4 weeks
Calculate for each component :

a.
Reorder level
b.
Minimum level
c.
Maximum level
d.
Average stock level.
Solution :
(1)
Reorder Level :
Maximum Lead time x Maximum Usage
X = 6 weeks x 75 units = 450 units
Y = 4 weeks x 75 units = 300 units.
(2)
Minimum Level :
Reorder Level (Normal Usage x Normal Leadtime)
X = 450 units (50 units X 5 weeks) = 200 units.
Y = 300 units (50 units x 3 weeks) = 150 units
214
(3)
Maximum Level :
Reorder Level + Reorder Quantity - (Minimum Usage x Minimum Leadtime)
X = 450 units + 400 units - (25 units x 4 weeks) = 750 units.
Y = 300 units + 600 units - (25 units x 2 weeks) = 850 units.
(4)
Average Stock Level :

Minimum Level + Maximum Level
2
200 units + 750 units
X =
2
Y =
= 475 units
= 500 units
2
As stated above, the expression of the Reorder Quantity in the calculation of Maximum level
indicates Economic Order Quantity. Hence, in some cases, it may be necessary to decide
the Economic Order Quantity before fixing the inventory levels.
Illustration :
Shriram Enterprises manufactures a special product ZED
The following particulars are collected for the year 1986.
(a)
Monthly demand of ZED - 1000 units.
(b)
Cost of placing an Order - Rs. 100.
(c)
Annual carrying cost per unit - Rs. 15.
(d)
Normal Usage 50 units per week.
(e)
Minimum Usage 25 units per week.
(f)
Maximum Usage 75 units per week.
(g)
Re-order period 4 to 6 weeks.
Compute from the above:

(1)
Re-order Quantity.
(2)
Re-order Level.
(3)
Minimum Level.
(4)
Maximum Level.
(5)
Average Stock Level.
Material Cost
215
Solution :
(1)
Reorder Quantity :
2xAxO
C
where
A = Annual Requirement
O = Ordering cost per cost
C = Carrying cost per unit per year
EOQ =
2 x 12000 x 100
15
= 400 units
(2)
Reorder Level :
Maximum Lead Time x Maximum Usage.
6 weeks X 75 units = 450 units
(3)
Minimum Level :
Reorder Level - (Normal Usage x Normal Lead Time)
450 units - (50 units X 5 weeks) = 200 units
(4)
Maximum Level :
Reorder Level + Reorder Quantity (Minimum Usage X Minimum Leadtime)
450 units + 400 units - ( 25 units X 4 Weeks) = 750 units.
(5)

Minimum Level + Minimum Level
2
= 475 units
2
There may be one more way in which the various inventory levels may be fixed and for this
determination of the safety stock (also called as minimum stock or buffer stock) is essential.
Safety stock is that level of stock below which the actual should not be allowed to fall. The
safety stock may be calculated as 216
(Maximum Usage X Maximum Leadtime) less

(Normal Usage X Normal Leadtime)
According to this method, the various inventory levels as discussed above may be fixed as
below.
(1)
Minimum Level :
It is equal to safety stock.
(2)
Maximum Level :
It can be calculated as - Safety Stock + EOQ.
(3)
Reorder Level :
It can be calculated as :
Safety Stock + (Normal Usage x Normal Leadtime)
(4)

It can be calculated as Minimum Level + Maximum Level
2
=
Safety Stock + Safety stock + EOQ

2
Safety Stock + EOQ

2
Illustration :
You have been asked to calculate the following levels for Part No. 007 from the information
given thereunder:
(a)
Re-ordering level,
(b) Maximum level
(c)
Minimum level,
(d) Danger level,
(e)
Average level.
The ordering quantity is to be calculated from the following data :

(i)
Total cost of purchasing relating to the order Rs. 20.
(ii)
Number of units to be purchased during the year 5,000
(iii) Purchase price per unit including transportation costs Rs. 50.
Material Cost
217
(iv)
Annual cost of storage of one unit Rs. 5.

Lead Times :
Average
... 10 days
Maximum
.. 15 days
Minimum
.. 6 days
Maximum for emergency purchases
... 4 days
Rate of consumption:Average
.. 15 units per day
Maximum
.. 20 units per day
Solution :
Working Notes :
(a)
Calculation of Safety Stock :

(Maximum Usage x Maximum Leadtime) - (Normal Usage x Normal Leadtime)
(b)
(20 units x 15 days) - (15 days x 10 days)
300 units - 150 units
150 units.
Calculation of EOQ :
2xAxO
C
where
Annual requirement
Ordering cost per order
Carrying cost per unit per year.
Hence,
EOQ =
=
(1)
2 X 500 X 20
5
200 units.
Reordering Level :
It can be calculated as Safety Stock + (Normal Usage x Normal Leadtime)
= 150 units + (15 units X 10 days)
= 150 units + 150 units = 300 units.
218
(2)
Maximum Level :
It can be calculated as Safety Stock + EOQ
= 150 units + 200 units = 350 units.
(3)
Minimum Level :
It is equal to Safety Stock
= 150 units.
(4)
Danger Level :
Normal Usage X Leadtime for emergency purchases
= 15 units X 4 days = 60 units.
(5)

It can be calculated as
Safety Stock +
= 150 units +
(3)
EOQ
2
200
2
units
= 250 units
Inventory Turnover :
Inventory turnover indicates the ratio of materials consumed to the average inventory
held. It is calculated as below :
Value of material consumed
Average inventory held
where
Value of material consumed can be calculated as :

Opening Stock + Purchases - Closing Stock.
Average inventory held can be calculated as :
Opening Stock + Closing Stock
2
Inventory turnover can be indicated in terms of number of days in which average inventory
is consumed. It can be done by dividing 365 days (a year) by inventory turnover ratio.
Material Cost
219
Illustration :
From the following data for the year ended 31st December, 1986, calculate the inventory
turnover ratio of the two items and put forward your comments on them.
Material A
Material B
Rs.
Rs.
Opening Stock 1.1.86
10,000
9,000
Purchases during the year
52,000
27,000
6,000
11,000
Closing Stock 31.12.86

Solution :
Inventory turnover ratio =
Value of material consumed

Average Inventory held
Inventory Turnover
Inventory Turnover Period =
Material A
Material B
56,000
25,000
8,000
10,000
2.5
Material A
Material B
365
365
2.5
52 days
146 days
A high inventory turnover ratio or low inventory turnover period indicates that maximum material
can be consumed by holding minimum amount of inventory of the same, thus indicating fast
moving items. Thus high inventory turnover ratio or lower inventory turnover period will always
be preferred.
Thus, knowledge of inventory turnover ratio or inventory turn over period in case of various
types of material will enable to reduce the blocked up capital in undesirable types of stocks
and will enable the organisation to exercise proper inventory control.
(4)
ABC Analysis :
This technique assumes the basic principle of Vital Few Trivial Many while considering the
inventory structure of any organisation and is popularly known as Always Better Control. It is
an analytical method of inventory control which aims at concentrating efforts in those areas
where attention is required most. It is usually observed that, in practice, only a few number of
items of inventory prove to be more important in terms of amount of investment in inventory or
220
value of consumption, while a very large number of items of inventory account for a very
meager amount of investment in inventory or value of consumption. This technique classifies
the various inventory items according to their importance. E.g. A Class consists of only a
small percentage of total number of items handled but are most important in nature. B Class
items include relatively less important items. C Class items consist of a very large number of
items which are less important. The importance of the various items may be decided on the
basis of following factors.
(i)
Amount of investment in inventory.
(ii)
Value of material consumption.
(iii) Critical nature of inventory items.

An example of ABC Analysis can be given as below.
Class
No. of items
% of total
No. of
items
Value/
Consumption
Rs.
% of Total Value/
Consumption
300
5,60,000
70
1500
30
1,60,000
20
3200
64
80,000
10
5000
100
8,00,000
100
In order to exercise proper inventory control, A Class items are watched very closely and
control is exercised right from initial stages of estimating the requirements, fixing minimum
level/leadtimes, following proper purchase/ storage procedures etc. Whereas in case of C
Class of items, only those inventory control measures may be implemented which are
comparatively simple, elaborate and inexpensive in nature.
Advantage of ABC Analysis :
(a)
A close and strict control is facilitated on the most important items which constitute a
major portion of overall inventory valuation or overall material consumption and due to
this the costs associated with inventions may be reduced.
(b)
The investment in inventory can be regulated in a proper manner and optimum utilisation
of the available funds can be assured.
(c)
A strict control on inventory items in this manner helps in maintaining a high inventory
turnover ratio.However it should be noted that the success of ABC analysis depends
mainly upon correct categorisation of inventory items and hence should be handled by
only experienced and trained personnel.
Material Cost
221
(5)
Bill of Materials :
In order to ensure proper inventory control, the basic principle to be kept in mind is that proper
material is available for production purposes whenever it is required. This aim can be achieved
by preparing what is normally called as Bill of Materials.
A bill of material is the list of all the materials required for a job, process or production order.
It gives the details of the necessary materials as well as the quantity of each item. As soon as
the order for the job is received, bill of materials is prepared by Production Department or
Production Planning Department.
The form in which the bill of material is usually prepared is as below :
BILL OF MATERIALS
No.
Date of Issue
Department authorised
S. No.
Description
Code
of Material
No.
Qty.
For Department Use only

Material
Requisition No.
Date
Remarks
Quantity
demanded
The functions of bill of materials are as below :
222
(1)
Bill of material gives an indication about the orders to be executed to all the persons
concerned.
(2)
Bill of material gives an indication about the materials to be purchased by the Purchases
Department if the same is not available with the stores.
(3)
Bill of material may serve as a base for the Production Department for placing the material
requisitions ships.
(4)
Costing/Accounts Department maybe able to compute the material cost in respect of a

job or a production order. A bill of material prepared and valued in advance may serve as
a base for quoting the price for the job or production order.
(6)
Perpetual Inventory System :

As discussed earlier, in order to exercise proper inventory control, perpetual inventory
system may be implemented. It aims basically at two facts.
(1)
Maintenance of Bin Cards and Stores Ledger in order to know about the stock in
quantity and value at any point of time.
(2)
Continuous verification of physical stock to ensure that the physical balance and
the book balance tallies.
The continuous stock taking may be advantageous from the following angles :
(1)
Physical balances and book balances can be compared and adjusted without waiting
for the entire stocktaking to be done at the year-end Further, it is not necessary to
close down the factory for Annual stocktaking.
(2)
The figures of stock can be readily available for the purpose of periodic Profit and
Loss Account.
(3)
Discrepancies can be located and adjusted in time.
(4)
Fixation of various levels and bin cards enables the action to be taken for the
placing the order for acquisition of material.
(5)
A systematic maintenance of perpetual inventory system enables to locate and

slow and non-moving items and to take remedial action for the same.
(6)
Stock details are available correctly for getting the insurance of stock.
(1)
The following informative is extracted from the Stores ledger in respect of Material X
Opening Stock
Nil
Purchases
Jan. 1
100 @ Re. 1 per unit
Jan. 20
100 @ Rs. 2 per unit
Issues
Jan. 22
60 for Job W 16
Jan. 23
60 for Job W 17
Complete the receipts and issues valuation by adopting the First In First Out, Last In First Out
and Weighted Average method. Tabulate the values allocated to Job W 16 and 17 and the
closing stock under the methods aforesaid.
Material Cost
223
Solution :
(a)
Valuation of receipts : (For all methods)

Jan. 1
100 x 1.00
Rs. 100
Jan. 20
100 x 2.00
Rs. 200
200 units
Rs. 300
Rs. 300
Weighted Average Rate =
= Rs. 1.50/Unit
200 units
(b)
Valuation of Issues/Closing Stock
(1) Issues
FIFO
Date
Jan. 22-W16
Jan.23-W17
(2)
(c)
Closing
Stock
Weighted Average
Qty.
Unit
Rate
Rs.
Amt.
Rs.
Qty.
Unit
Rate
Rs.
Amt.
Rs.
Qty.
Unit
Rate
Rs.
Amt.
Rs.
60
40
20
1.00
1.00
2.00
60.00
40.00
40.00
140.00
60
40
20
2.00
2.0
1.00
120.00
80.00
20.00
220.00
60
60
1.50
1.50
90.00
90.00
160.00
80
80.00
80
80
2.00
1.00
180.00
1.50 120.00
Values allocated to individual jobs

W 16
W 17
Rs.
Rs.
FIFO
60
80
LIFO
120
100
90
90
Weighted Average
(2)
LIFO
From the records of an oil distributing company, the following summarised information is
available for the month of March 1986.
Sales for the month - Rs. 19,25,000
Opening Stock as on 1-3-86 - 1,25,000 Litres @ Rs. 6.50 litre
Purchases (including freight and insurance)
March 5 -1,50,000 litres @ Rs. 7.10 litre
224
March 27 - 1,00,000 litres @ Rs. 7.00 litre.

Closing stock as on 31-3-86 - 1,30,000 litres
General Administrative expenses for the month Rs. 45,000
On the basis of the above information, work out the following using FIFO and LIFO
methods of inventory valuation assuming pricing of issues is being done at the end of the
month (after all receipts during the month).
(a)
Value of Closing Stock as on 31-3-86
(b)
Cost of goods sold during March 86
(c)
Profit or Loss for March 86.
Solution :
(a)
(1)
Value of Closing Stock

FIFO :
Under this method, the value of closing stock will constitute the value of latest available lot for
consumption, earlier lots assumed to have been consumed. As such, value of closing stock
will be:
Purchased on 27-3-86
1,00,000 Its. x Rs. 7.00
Rs. 7,00,000
Purchased on 5-3-86
30,000 Its. x Rs. 7.10
Rs. 2,13,000
Rs. 9,13.000
(2)
LIFO :
Under this method, the value of closing stock will constitute the value of earliest available lot
for consumption, latest lots assumed to have been consumed. As such, value of closing stock
will be :
Opening Stock on
1-3-86 1,25,000 Its. x Rs. 6.50
Rs. 8,12,500
Purchased on
5-3-86 5,000 Its. x Rs. 7.10
Rs. 35,500
Rs. 8,48,000
Material Cost
225
(b)
Cost of goods sold during March 1986
Opening Stock 1,25,000 Its. x Rs. 6.50

Purchases
Less : Closing Stock (as per a above)
FIFO
Rs.
LIFO
Rs.
8,12,500
8,12,500
17,65,000
17,65,000
25,77.500
25,77,500
9,13,000
8,48,000
16,64,500
17,29,500
The value of purchases is calculated as below :

Purchased on
5-3-86 1,50,000 X Rs. 7.10
Rs. 10,65,000
Purchased on
27-3-86 1,00,000 X Rs. 7.00
Rs. 7.00,000
Rs. 17,65,000
(c)
Profit or Loss for March 1986
(1)
Sales
FIFO
Rs.
LIFO
Rs.
19,25,000
19,25,000
16,64,500
17,29,500
45,000
45,000
17,09,500
17,74,500
2,15,500
1,50,500
Total Cost
Cost of goods sold
226
(2)
Profit (1 - 2)
(3)
A company uses annually 50,000 units of an item each costing Rs.1.20. Each
older costs Rs. 45 and inventory carrying costs 15% of the annual average inventory
value.
(a)
Find EOQ
(b)
If the company operates 250 days a year, the procurement time is 10 days, and
safety stock is 500 units, find reorder level, maximum, minimum and average
inventory.
Solution :
(a)
Economic Order Quantity
2 X A X O
Ci
2 X 50,000 X 45
15% of 1.20
=
(b)
(1)
5,000 units
Reorder Level :
Safety Stock + (Normal Usage x Normal Leadtime)

= 500 units + (200 units x 10 days) =
(2)
2,500 units
Maximum Level :
Safety stock + EOQ
= 500 units + 5,000 units
= 5,500 units
(3)
Minimum Level
It is equal to safety stock i.e. 500 units
(4)
Average Level
Safety Stock +
(4)
500 units +
3000 units
EOQ
2
5000 units
2
M/s. Kailas Pumps Ltd. uses about 75,000 valves per year and the usage is fairly constant
at 6,250 per month. The valve costs Rs. 1.50 per unit when purchased in quantities and
inventory carrying cost is 20%. The average inventory investment on annual basis. The
cost to place an order and to process the delivery is Rs. 18. It takes 45 days to receive
from the date of an order and minimum stock of 3,250 valves is desired. You are required
to determine -
Material Cost
227
a.
The most economical order quantity and the number of orders in year.
b.
The reorder level
c.
The most economic order quantity if valve costs Rs. 4.50 each instead of Rs. 1.50
each.
Solution :
(a)
Economic Order Quantity :
EOQ
2xAxO
Ci
2 x 75,000 x 18
3,000 units
20% of 1.50
Number of Orders :
Annual Consumption
EOQ
75,000 units
=
(b)
3,000 units
25
Reorder Level :
Safety stock + (Normal Usage x Normal Leadtime)
(c)
3,250 units + (6,250 units x 1.5 months)
12,625 units
Revised EOQ
(If unit cost is Rs. 4.50 instead of Rs. 1.50)
EOQ
=
=
2xAxO
Ci
2 x 75,000 x 18
20% of 4.50
228
1,732 units
(5)
The Purchase Department of your Organisation has received an offer of quantity discounts
on its orders of materials as under :
Price Per Tonne
Tonnes
1,200
Less than 500
1,180
500 and less than 1000
1,160
1,140
1,120
3000 and above.
The annual requirement for the material is 5000 tonnes. The delivery cost per order is Rs.
1,200 and the stock holding cost is estimated at 20% of material cost per annum. You are
required to advice the Purchase Department the most economic purchase level.
Solution :
As the price discount varies with lot size, EOQ will have to be decided by Trial and Error
Method.
Lot Size
Price per
Purchase
Ordering
Carrying
Total
(Units)
Tonne-Rs.
Cost for
Cost
Cost
Cost
5,000
Tonnes
Rs.
5000
Rs.
Q
X 1200
X P X 20%
2
6(3+4+5)
100
1200
60,00,000
60,000
12,000
60,72,000
250
1200
60,00,000
24,000
30,000
60,54,000
500
1180
59,00,000
12,000
59,000
59,71,000
625
1180
59,00,000
9,600
73,750
59,83,350
1,000
1160
58,00,000
6,000
1,16,000
59,22,000
1,250
1160
58,00,000
4,800
1,45,000
59,49,800
2,000
1140
57,00,000
3,000
2,28,000
59,31,000
2,500
1140
57,00,000
2,400
2,85,000
59,87,400
3,000
1120
56,00,000
2,000
3,36,000
59,38,000
4,000
1120
56,00,000
1,500
4,48,000
60,49,500
Material Cost
229
It will be observed, that if the purchases are made in the lot size of 1,000 units it proves to be
most economical.
(6)
(a)
(b)
A company needs 24,000 units of raw materials which costs Rs. 20 per unit and
ordering cost is expected to be Rs. 100 per order. The company maintains safety
stock of 1 months requirements to meet emergency. The holding cost of carrying
inventory is supposed to be 10% per unit of average inventory. Find out :
1.
Economic lot size.
2.
Ordering cost
3.
Holding cost
4.
Total cost
The supplier of raw material has agreed to supply the goods at a discount of 5% in
price on a lot size of 4,000 units. Find whether the concession price should be
availed.
Solution :
(a)
(1)
Economic Lot Size
=
(2)
2xAxO
Ci
2 x 24,000 x 100
10% of 20
1,550 units (Approx.)
Ordering Cost
Annual Requirement
EOQ
=
24,000
1550
(3)
X 100 = Rs. 1,548 (Approx.)
Holding Cost :
As the company maintains safety stock of one months requirement, the average inventory
held at any point of time will not only be EOQ/2 but safety stock + EOQ/2. Assuming
that the usage of raw material is steady throughout the year i.e. 2,000 units per month,
holding cost will be :
230
(Safety Stock + EOQ/2) / Carrying cost per unit per year
(4)
1,550 units
(2,000 units +
2,775 units X Rs. 2
Rs. 5,550
) X 10% of Rs. 20
Total cost :
Cost of material 24,000 x 20
Rs. 4,80,000
Ordering Cost
Rs. 1,548
Holding Cost
Rs. 5,550
Total Cost
Rs. 4,87,098
(b)
Revised Total Cost : (with 5% discount)
(1)
Ordering Cost :
As order size is going to be 4,000 units, total 6 orders will be placed. Hence total ordering cost
will be 6 orders x Rs. 100 per order i.e. Rs. 600
(2)
Holding Cost :
The holding cost will be as below :

(Safety Stock +
Order Size
(2,000 units +
Rs. 7,600
(3)
Total Cost :
) x Carrying cost per unit per year
2
4000 units
) x 10% of Rs. 19
Total Cost of material - 24,000 x 19
Rs. 4,56,000
Ordering Cost
Rs. 600
Holding Cost
Rs. 7,600
Total Cost
Rs. 4,64,200
Material Cost
231
Conclusion :
If purchased in Economic Lot Size, total cost (including material cost) is Rs. 4,87,098.
If purchased in Lot Size of 4,000 units with 5% discount, total cost (including material cost) is
Rs. 4,64,200.
As purchases in Lot Size of 4,000 units result in the saving of Rs. 22,898 (i.e. Rs. 4,87,098 Rs. 4,64,200) that alternative will be preferred.
QUESTIONS
232
1.
Explain the various steps in which a raw material moves in a manufacturing organization
till it gets consumed in the production. Give the format of various documents which are
prepared in the process.
2.
Write a detailed essay on a)
Valuation of Receipts
b)
Valuation of Issues
c)
Valuation of Returns
PROBLEMS
(1)
The following is the record of receipts and issues of certain material in a factory during
the week ending May 1979.
Opening balances 100 tons at Rs. 10 per ton.
Issued 60 tons.
Received 120 tons at Rs. 10 per ton
Issues - 50 tons (Stock verifier reported shortage of 2 tons)
Received back from order 20 tons (originally issued at Rs. 9.90)
Issued 80 tons.
Received 44 tons at Rs. 10.20 per ton.
Issued 66 tons.
Received 44 tons at Rs. 10.20 per ton.
Issued 66 tons.
From the above particulars prepare stores ledger separately under e method charging
issues at weighted and simple average method.
(2)
Following transactions appeared in a specified material during month of August 1980.

Date
Particular
Quantity (Tons)
Rate per ton
Opening balance
100
24
Purchased
50
26
Issued
30
12
Issued
40
13
Purchased
30
19
Issued
40
25
Issued
30
30
Purchased
40
31
Issued
30
25
28
The stock verifier noticed shortage in stock on 26th August of 5 tons and on 29th August
of 4 tons. Write up stores ledger by charging issues by FIFO and by weighted average
methods.
(3)
The following is the history of the receipt and issue of materials in a factory during
February 1980,
Material Cost
233
Feb. 1
Opening balance -500 tons at Rs. 25
Issued 70 tons
Issued 100 tons
Issued 80 tons
13
Received from vendor 200 tons at Rs. 24.50
14
Refund of surplus from a work order 15 tons at Rs. 24
16
Issued 180 long
20
24
Issued 304 tons
25
26
Issued 112 tons
27
Refund of surplus from a work order 12 tons at Rs. 24.50
28
Received from vendor 100 tons at Rs. 25
Issues are to be priced on the principle of LIFO and simple average method. The stock
verifier of the factory noted that on the 15th he had found a shortage of 5 tons and on 27th
another shortage of 8 tons. Write out complete stores ledger account in respect of the
material.
(4)
A cloth manufacturer commenced the business on 1.1.82. Textile materials used include
two types - M & N. During 6 months ending on 30.6.82, transactions were as
follows :
Date
Purchased (Mtrs.)
M
4.1.82
1000
6.1.82
Issued (Mtrs.)
Rates per Mt.
10
1600
15
7.1.82
700
12.1.82
18.3.82
1200
2300
12
28.3.82
1420
16.4.82
3000
16
22.4.82
26.5.82
2860
800
9.50
1.6.82
2.6.82
8.6.82
234
1580
1000
17.50
1300
You are required to prepare stores ledger account for M type of material by charging
issues by LIFO method and N type of material by charging the issues on weighted
average method.
(5)
The stores ledger account of material C in the books of Saurabh and Sweta Ltd. revealed
following transactions for September 1984,
Sept.
Opening stock 200 kgs at Rs. 7.50 per kg.
Received from supplier 400 kgs at Rs. 7.75 per kg GRN 448
Issued to Production Dept. 240 kgs SR No. 883
10 Received from supplier 500 kgs at Rs. 7.90 per kg. GRN 45
12 Issued to Production Dept. 160 kgs SR No. 897
16 Received from supplier 250 kgs at Rs. 8.00 per kg GRN 469
19 Received from supplier 600 kgs at Rs. 8.25 per kg GRN 561
You are required to price the issues and draw out the closing balance in the stores
ledger account under the pricing method in which the material costs charged to production
would be closely related to current prices.
(6)
Record the following transactions in a store ledger and show the cost of consumption
and closing stock by using FIFO method of pricing issues.
For the month of January 1985 :
Jan. 1
Opening Stock 300 units at

Rs. 9.70 per unit
3
Purchases 250 units at
Rs. 9.80 per unit
15 Purchases 300 units at
Rs. 10.50 per unit
25 Purchases 150 units at
Rs. 10.30 per unit
Material Cost
Jan.
11 Issues
20 Issues
29 Issues
400 units
210 units
100 units
235
(7)
Prepare a stores ledger account on the basis of FIFO method.

Jan. 1
(8)
Opening stock
250 units
@ Re. 1 each
Purchased
100 units
@ Rs. 1.05 each
Purchased
200 units
@ Rs. 1.05 each
Issued
400 units
10 Purchased
400 units
12 Issued
150 units
13 Issued
100 units
16 Purchased
100 units
@ Re. 1 each
22 Purchased
200 units
@ Rs. 1.25 each
31 Issued
300 units
@ Rs. 1.20 each
The following is a summary of the receipts and issues of a material in a factory during a
month.
1st Opening Balance 500 units at Rs. 25 per unit.
3rd Issued 70 units.
4th Issued 100 units.
13th Receipts 200 units at Rs. 24.50 per unit (Supplier)
14th Returned to stores 15 units at Rs. 24 per unit.
27th Returned to stores 12 units at Rs. 24.50 per unit
28th Received from supplier 100 units at Rs. 25 per unit.
Stock verification revealed that on 15th there was a shortage of 5 units and another on
27th of 8 units. Prepare Stores Ledger Account on the basis of FIFO basis.
236
(9)
Following is an extract of receipts and issues for the month of January 1989 of a
manufacturing company.
Date
Purchased
8,000 units
@ Rs. 2
Purchased
1,000 units
@ Rs. 2.50
Issued
4,000 units
10
Purchased
12,000 units
15
Issued
8,000 units
19
Issued
2,000 units
22
Issued
4,000 units
25
Purchased
9,000 units
30
Issued
6,000 units
@ Rs. 3
@ Rs. 2.75
Draw up store Ledger Account by LIFO method showing balance as on 31.1.89

(10) The transactions in connection with the materials are as follows :
Days
Receipts
Rate per unit Rs.
Issues (Units)
Unit
1st
40
15.00
2nd
20
16.50
3rd
30
4th
50
14.30
5th
20
6th
40
Calculate the cost of material issued under FIFO method and Weighted Average method
of issue of materials.
(11) From the following details of stores receipts and issues of Material EXE in a manufacturing
unit, prepare the stock ledger using Weighted Average method of valuing the issues.
Nov. 1 Opening Stock 2,000 units (S) Rs. 5.00 each
Nov. 3 Issued 1,500 units to production
Nov. 4 Received 4,500 units @ Rs. 6.00 each
Nov. 8 Issued 1,600 units to production.
Nov. 9 Returned to stores 100 units by production department (from the issues of Nov. 3)
Material Cost
237
Nov. 19 Returned to supplier 200 units out of the quantity received on Nov. 4Nov. 20
Received 1,000 units @ Rs. 7 each.
Nov. 24 Issued to production 2,100 units
Nov. 29 Issued to Production 2,800 units (Use rates upto two decimal places)
(12) The following are the transactions in respect of purchases and issues of components
forming part of an assembly of a product manufactured by a firm which requires, to
update its cost of production very often for bidding tenders and finalising cost plus
contracts.
Date
1986
January
February
March
Quantity
(in Nos.)
Particulars
1,000
Purchased @ Rs. 1.20 each
11
2,000
Issued
1,500
18
2,400
Issued
26
1,000
Issued
1,000
17
1,500
28
2,000
Issued.
The stock on 1st January 1986 was 5,000 Nos. valued at Rs. 1.10 each. State the
method you would adopt in pricing the issues of components giving reasons. What value
would you place on stocks as on 31st March which happens to be the financial year end
and how would you treat the difference in value, if any, on the stock account.
(13) The following are the extract from the transactions on the bin card of Job No. 12-3-89 for
March 1987
Date
238
On order
Receipt
Rate
Issue
Balance
40
25.00
40
20
20
50
28.00
70
12
30
40
15
30
24.00
70
18
50
26.00
70
28
50
20
Find out the pricing of material issue under LIFO, FIFO and simple average method.
(14) XYZ Ltd. requires 20,000 units of product A per annum. The purchase price is Rs. 4 per
unit. The inventory carrying cost is 20% per annum and the cost of ordering is Rs. 100
per order. Advise the company, on how many times they should order in a year, so as to
minimise the cost of product A?
(15) A Manufacturer buys certain essential spares from outside suppliers at Rs. 40 per set.
Total annual requirements are 45000 sets. The annual cost of investment in inventory is
10% and costs like rent, stationery, insurance, taxes etc. per unit per year work to Re.
1, cost of placing an order is Rs. 5. Calculate the Economic Order Quantity.
(16) Following information relating to a type of raw material is available.
Annual Demand
2,400 units
Unit Price
Rs. 2.40
Rs. 4.00
Storage cost
27% p.a.
Interest Rate
10% p.a.
Lead Time
Half month
Calculate Economic Order Quantity and total annual inventory cost in respect of the
particular raw material.
(17) From the particulars given below, you are required to compute.
(a)
(b)
Maximum Level
(c)
Minimum Level
(d)
Re-ordering Level
(e)
Average stock Level

(i)
Quantity required annually 3,000 units @ Rs. 5 per unit.
(ii)
Interest and cost of storing 10%.
(iii)
Cost of placing an order Rs. 30 per order.
(iv)
Consumption per week Normal 60 units

Maximum 70 units
Minimum 50 units.
(v)
Material Cost
Lead time (in weeks)
Normal 5
Maximum 6
Minimum 4
239
(18) The Stock-Ledger Account for material X in a manufacturing concern reveals the following
data for the quarter ended September 30, 1989.
Receipts
July
Issues
Quantity
Units
Price
Rs.
Quantity
Units
Amount
Rs.
1.600
2.00
1 Balance b/d
July
3,000
2.20
July
13
1,200
2,556
August
900
1,917
August
17
3,600
2.40
August
24
1,800
4,122
September
11
2,500
2.50
September
27
2,100
4,971
September
29
700
1,656
Physical verification on September 30, 1989 revealed an actual stock of 3,800 units. You are
required to :
(a)
Indicate the method of princing employed in the above.
(b)
Complete the above account by making entries you would consider necessary including
adjustments, if any, and giving explanations for such sdjustments.
(19) Following information is available in respect of two components A and B.

Particulars
Normal Usage
Units
50
50
Minimum Usage
Units
25
25
Maximum Usage
Units
75
75
Lead Time
Week
4-6
2-4
Annual Consumption
Units
9,000
6,250
Rs.
45
100
Carrying cost per unit per year
Rs.
Calculate for each component.
240
(i)
Re-order level
(ii)
Minimum level
(iii) Maximum level

(iv)
Average level
(20) P. Ltd. uses three types of materials, A, B and C for production of X, the final product.
The relevant monthly data for the components are as given below :
A
Normal Usage (Units)
200
150
180
Minimum Usage (Units)
100
100
90
Maximum Usage (Units)
300
250
270
Re-older Quantity (Units)
750
900
720
Re-order period (Months)
2 to 3
3 to 4
2 to 3
Calculate for each component.

(1)
Re-order Level
(2)
Minimum Level
(3)
Maximum Level
(4)
Average stock Level
(21) The following data are available from the records of M/s. Naveen Industries Ltd. using two
types of materials A and B for the manufacture of their product.
A
Normal Usage (Units per month)
250
200
Minimum Usage (Units per month)
100
200
Maximum Usage (Units per month)
350
400
Reorder Quantity (Units)
900
1000
Reorder Period (Months)
2 to 3
3 to 4
Compute for each type of material, the following levels.

(1)
Reorder Level
(2)
Minimum Level
(3)
Maximum Level
(4)
Average Stock Level
Material Cost
241
(22) Following details are available in respect of a material.

(i)
Ordering cost per order Rs. 45
(ii)
Annual consumption 9,000 units
(iii) Carrying cost per unit per year Rs. 9

(iv)
Lead Times -
Average - 10 days
Minimum 6 days
Maximum 15 days
Maximum for emergency purchases 4 days
(v)
Rate of consumption - Average 15 units per day

Maximum 20 units per day
Calculate :
(i)
Reordering Level
(ii)
Maximum Level
(iii) Minimum Level

(iv)
Average Level
(23) Certain purchased part of which annual requirements are 8000 units, involves ordering
cost equal to Rs. 12.50 per order, cost per piece Re. 1 and the annual carrying cost
20%. In addition, average daily usage is 32 units (based on 250 operating days per
year), lead time is 10 days and safety stock has been calculated to be 100 units.
Calculate :
(a)
(b)
Reorder point
(24) (i)
(ii)
XYZ Company buys in the lot of 500 boxes which is a 3 months supply. The cost
per box is Rs. 125 and the ordering cost is Rs. 150. The inventory carrying cost is
estimated at 20% of unit value. What is the total annual cost of the existing inventory
policy?
How much money could be saved by employing the economic order quantity?
(25) To decided to buy an item, the following data is given.

Annual Demand 600 units
Ordering Cost - Rs. 400
Holding Cost - 40%
242
Cost per unit - Rs. 15

Discount 10% if the order quantity is 500
What should be the decision? Justify your answer.
(26) A manufacturer requires 10 lakhs components for use during the next year which is
assumed to consist of 250 working days. The cost of storing one component for one
year is Rs. 4 and the cost of placing order is Rs. 32. There must always be a safety
stock equal to two working days usage and the lead time from the supplier, which has
been guaranteed, will be 5 working days throughout the year.
Assuming usage takes place steadily throughout the working days, delivery takes place
at the end of the day and orders are placed at the end of working day, you are required to
calculate.
(i)
Economic Order Quantity.
(ii)
Reorder point.
(27) Anil Company buys its annual requirement of 36,000 units in six instalments. Each unit
costs Re. 1 and the ordering cost is Rs. 25. The inventory carrying cost is estimated at
20% of the unit value. Find the total cost of the existing inventory policy. How much
money can be saved by using Economic Order Quantity?
(28) A Company, for one of the A class items, placed 6 orders each of size 200 in a year.
Given ordering cost Rs. 600, holding cost 40%, cost per unit Rs. 40, find out the loss to
the Company by not operating scientific inventory policy. What are your recommendations
for the future?
(29) A manufacturer has to supply his customers 600 units of his product per year. Shortages
are not allowed and the inventory carrying cost amounts to Rs. 0.60 per unit per year.
The set up cost per run is Rs.80. Find
(a)
The Economic Order Quantity
(b)
The minimum average yearly cost.
(c)
The optimum number of orders per year.
(30) A purchase manager has decided to place order for minimum quantity of 500 numbers of
a particular item in order to get a discount of 10%. From the records, it was found that in
the last year, 8 orders each of size 200 number have been placed. Given Ordering cost
Rs. 500 per order, Inventory carrying cost 40% of the inventory value and cost per unit
Rs. 400, is the purchase manager justified in his decision. What is the effect of his
decision on the company?
Material Cost
243
(31) A publishing house purchases 2000 units of a particular item per year at a unit cost of
Rs. 20, the ordering cost per order is Rs. 50 and the inventory carrying cost is 25%. Find
the optimal order quantity and minimum total cost including purchase cost.
If a 3% discount is offered by the supplier for purchase in lots of 1000 or more, should the
publishing house accept the proposal?
(32) Calculate for each Component A and B the following (a)
Reorder Level
(b)
Maximum Level
(c)
Minimum Level
(d)
Average stock Level
Normal Usage
Maximum Usage
450 units per week each
Minimum Usage
150 units per week each
Reorder Quantity
- A - 2,400 units
B - 3,600 units
Reorder Period
A - 4 to 6 weeks
B - 2 to 4 weeks
244
NOTES
Material Cost
245
NOTES
246
Chapter 9
LABOUR COST
Labour Cost is another important element of cost in the manufacturing cost. It is important
element of cost eventhough the production is material intensive. The basic factor which gives
rise to the labour cost is the remuneration paid to workers. However, the objective of cost
accounting (i.e. cost ascertainment with respect to the individual cost centre and cost control)
can not be fulfilled properly unless and until the functions performed by the related departments
are properly considered. These functions can be stated as below :
(1)
Personnel Department : This ensures the availability of correct workers to perform the
jobs which are best suited for them. This is done by selecting them properly and training
them properly. This department may also be involved with maintenance of records of job
classification/ wage rates payable to workers, preparation of wages sheet and procedural
aspects of wage payment.
(2)
Time Keeping Department : This is concerned with recording of workers time. This is
not only for the purpose of wage calculations but also for the purpose of cost analysis
and apportionment of cost over various jobs. The main functions performed by this
department are time keeping and time booking.
(3)
Cost Accounting Department : This department accumulates and classifies cost data
with respect to labour cost from the analysis of wages sheet and presents the reports to
management to facilitate the control over labour cost.
The starting point for ascertaining the labour cost is in the form of Time Keeping and Time Booking.
Time Keeping :
This is the process of recording attendance time of the workers. It is the responsibility of Time
Keeping Department which may function as separate department in some cases or else may
function as the part of Personnel Department. Attendance time recording may be necessary
as the payment of wages may depend on the attendance. Even when the payment of wages
does not depend on time attended, say in case piece rate payment, the recording of time
attended may be necessary from the following angles.
Labour Cost
247
(1)
To Maintain discipline.
(2)
Though the regular wages may not depend upon the time attended, in some cases, the
other payments like overtime wages, dearness allowance etc. may be linked with the
attendance.
(3)
The fringe benefits like Pension, Gratuity on retirement. Provident Fund etc. may depend
on the continuity of service which will be available only if time attended is recorded
properly.
(4)
Attendance records may be required for research and other purposes.
Methods of Time Keeping :

For the purpose of time keeping, various methods may be followed, though the selection of the
method may depend upon nature of organization and policy of management. Main such methods
may be stated as below:
(1)
Hand-Written Method :
Under this method, names of the workers are recorded in the attendance register with
provision of various columns for various days. The attendance of the worker may be
recorded either by calling out his name or by physical check. Alternatively, the workers
themselves may sign in the attendance register.
This method, though simple, has become outdated. This method can also result in
malpractices with the collusion between workers and time keeping/ personnel department.
Also recording of late coming, overtime, short leave etc. may involve more clerical work
and may be subject to errors.
(2)
Token or Disc Method :

Under this method, each worker is allotted an identification number and a disc or token
bearing that number. Immediately before the scheduled opening time, all the tokens/
discs will be placed at the factory gate. Every incoming worker will take out his token
and drop it in a separate box or hang it on a separate board. The tokens/discs not
removed will indicate that the said worker is absent. Similar procedure is followed while
the workers leave the factory. In addition to the physical handling of tokens/ discs, it will
be required to record the attendance time separately.
Though it is an improved method, as compared to manual/handwritten method, it is also
subject to errors.mistakes and frauds. Further care should be taken to see that a worker
does not remove the disc/token of his absent fellow in addition to his own.
248
(3)
Time Recording Clock Method :

Under this method, every worker is alloted individual ticket number and a clock card
which bears that ticket number. The cards are placed on two racks on either side of the
time recording clock denoting separately In rack and Out rack. At the opening time, all
the cards are placed in Out rack. On arrival, worker takes out his own card, puts it in the
slot available on the time clock recorder which punches the time on that card, and
places the card in In rack. All the cards, left in the Out rack indicate absent workers.
At the time of departure, he removes the card from In rack, gets it punched and places
it in Out rack.
Though, this method involves heavy capital outlay initially, it has certain advantages
also.
(1)
It is economical in the sense it avoids clerical work: involved in manual/handwritten

method.
(2)
It is clean, safe and quick and has printed records to avoid disputes.
(3)
Chances of fraudulent entries being made can be avoided.
Time Booking :
The ultimate aim of costing is to decide the cost of each cost centre. As such, recording of
time attended is not sufficient. Equally important is to record the time spent for individual cost
centres. This process is in the form of time booking. The methods followed for this purpose,
may be considered as below :
(a)
Daily time sheets :
Under this method, each worker is provided with a daily time sheet on which time spent by
him on various jobs/work orders is expected to be mentioned. If the worker works on various
jobs in a particular day, the daily time sheets move along with the worker. The entries on the
same may be made by the worker himself or by the foreman.
This method may be conveniently used if the worker works on various jobs of short duration.
Say in case of maintenance jobs.
This method is disadvantageous in the sense that it involves considerable paper work. The
form in which the daily time sheets may be prepared is as below :
Labour Cost
249
DAILY TIME SHEET

Name of Employee
Employee No.
Job No.
Date :
Dept.
Time Record
ON
Time taken
OFF
Checked by
(b)
Cost office reference
Weekly Time Sheets :
Under this method also; one sheet is alloted to each worker but instead of recording the work
done for a day only, record of time for all the jobs during the week is made. These types of time
sheets are useful for intermittent types of jobs like building or construction work. It involves
comparatively less paper work. The form in which weekly time sheets may be prepared is as
below.
WEEKLY TIME SHEET
Name of Employee
Week ending on...
Employee No.
Day
Job No.
Time
On
Off
Time
taken
Standard
Rate
Amount
TOTAL
Checked by
250
(c)
Job Card :
Under this method, the details of time are recorded with reference to the jobs or production/
work orders undertaken by the workers rather than with reference to individual workers, and
this facilitates the computation of labour cost with reference to jobs or production/work orders.
There may be two ways in which job card may be maintained.
(1)
According to first method, each job or production/work order is alloted a number. When
a worker takes up a job, the time of starting and finishing the job is entered on the card
meant for that worker. The summary of this card states the total time taken by that
worker for that job. In order to compute the total time booked for the job as a whole, all
cards of all the workers with respect to that job are required to be analysed. The form in
which this card may be prepared is as below.
JOB CARD
Name of Employee
Job No.
Employee No.
Day
Time
ON
OFF
Time
Taken
Standard
Rate
Rs.
Amount
Rs.
FRI
SAT
SUN
MON
TUE
WED
Checked by
(2)
According to this method, a job card is prepared for each job production/work order
accepted by the organization for execution. It describes the various operations/stages
involved in the execution of the job. Time taken by the various workers to complete the
job is entered on the card. This provides the information about the time taken by various
workers to complete a particular job.
Labour Cost
251
The form in which this card may be prepared is as below.

JOB CARD WITH OPERATIONS
Job No.
Drawing No.
Job Description
Operation
Employee
No.
ON
OFF
Time
taken
Rate
Amount
Cutting
1
2
Drilling
1
2
Grinding
1
2
Painting
1
2
Assembly
1
2
3
TOTAL
Checked by
Reconciliation of time attended and time booked

If a combined time and job card is maintained, the problem of reconciliation will be relatively
simple as both the details will be available on the same card. In other cases, at the end of the
wage period or at a shorter interval also, the total time attended has to be compared with the
time booked on job cards on the various jobs. If the time booked as per the job cards, is less
than the attendance time, this indicates the idle time during which the worker has not done
any work, though he was present in the factory.
252
Methods of remunerating the workers :

Remuneration to workers indicate the reward for labour and services. The remuneration may
be paid in monetary terms (which in turn may be in direct form or indirect form) or nonmonetary terms. The remuneration paid in the monetary form may be by way of basic wages
or salaries and other allowances and may be paid either on time basis or on work basis.
However, payment of only basic wages or salaries may not be sufficient enough to induce the
workers to work efficiently, hence they may be remunerated in the form of some incentives. In
case of remuneration in non-monetary form, the workers may not receive anything in the from
money but they may get facilities which induce them to stay with the organization. It may be
in the form of the provision of health or welfare or recreational facilities, provision of working
conditions and so on. We will discuss these methods of remuneration under the following
heads.
(1)
Remuneration on Time Basis i.e. Time Rate System.
(2)
Remuneration on Work Basis i.e. Payment by Results.
(3)
Incentive/Bonus Systems.
(4)
(5)
(a)
Individual Incentive Systems
(b)
Group Incentive Systems.
Indirect monetary remuneration

(a)
Profit sharing
(b)
Co-partnership
Non-monetary incentives
Principles of a good wage payment system :

(1)
As a general rule, if the efficiency of the workers can be measured in the objective terms,
the wages receivable by a worker should be in conformity with his efficiency. Otherwise
an efficient worker is likely to be demotivated from working efficiently. At the same time,
the standards fixed to measure the efficiency of a worker should be normal which can be
attained by a normal worker under normal conditions.
(2)
The wage payment system should be clearly defined and communicated to the workers
leaving no scope for any ambiguity. At the same time, a good wage payment system
should be simple to understand and easy to operate.
(3)
No upper limit should be imposed on the wages which can be earned by an efficient
worker.
Labour Cost
253
(4)
A good wage payment system will not punish the workers for the matters beyond the
control of the workers. E.g. Workers should not be punished in terms of reduced wages
due to the circumstances like machinery break down or power failures etc.
(5)
A good wage payment system should be reasonably permanent in nature. Frequent

changes in the same should be avoided. If any changes are proposed to be made in
system of wages payment, they should not be thrust upon the workers by force, but
should be implemented by having mutual discussions with and due approval from the
workers.
(6)
Wage payment system should be properly tied up with quality control procedures to
ensure that the workers are paid only for good and quality production.
(7)
The basic objective of the wage payment system should be to get maximum cooperation
from the workers, improve the morale and productivity of the workers and to minimize the
cost of supervision and labour turnover.
(8)
The wage payment system should take into consideration the external obligations to
which the organization may be subjected to. These obligations may be in the form of
various statutes like Minimum Wage Act and the agreement entered into with the workers
and so on.
(A)
Time Rate System :
Under this, a worker is paid on the basis of time attended by him. He is paid at a specific rate
irrespective of the production achieved by him. The pay rate may be fixed on daily basis,
weekly basis or monthly basis.
This type of remuneration system is helpful in the following circumstances.
(a)
If the output of the worker is beyond his control e.g. His speed depends upon speed of a
machine or speed of other workers.
(b)
If the output cant be measured or standard time cant be fixed e.g. Maintenance work.
(c)
If close supervision is possible.
(d)
If quality, accuracy and precision in work is of prime importance e.g. Artist, Ad-agency
person.
The time rate system of remunerating the workers is useful due to the following features :
254
(a)
Useful for highly efficient and highly inefficient workers.
(b)
Easy for calculations.
(c)
Easy to understand for the worker.
(d)
Assurance of minimum wages.

The time rate system has one most important disadvantage attached to it that the efficiency
of the worker is disregarded while paying remuneration to him. To avoid this difficulty, some
variations as discussed below can be applied in practice.
(i)
High Wage Plan :
Under this system, timely wage rate of the workers may be fixed at such a level which is
higher as compared to wages paid to workers in the same industry or locality. Suitable working
conditions are provided. Correspondingly, a high standard of efficiency is expected from the
workers.
Those who are not able to come up to the standard, are taken off the scheme.
(ii)
Differential Time Rate :
Under this method, different hourly rates are fixed for different levels of efficiency. Up to a
certain level of efficiency, normal day rate is applicable which gradually increases as efficiency
increases. This can be illustrated as below :
Up to 80% efficiency
Re. 1.00 per hour (Normal Rate)
80% to 90% efficiency
Rs. 1.25 per hour
Rs. 1.40 per hour
Rs. 1.50 per hour
(B)
Payments by results :
Under this system, workers are paid according to the production achieved by them. In many
cases, time attended is not material. These methods can be reclassified as below.
(a)
Straight Piece Rate System :
Under this method, each job, production or unit of production is termed as a piece and the rate
of payment is fixed per piece. The worker is paid on the basis of production achieved irrespective
of the time taken for its performance. Thus, the earnings of the worker can be computed as :
Wages = No. of units produced x Piece Rate per unit This method can be suitably applied if
the production is of standard or repetitive nature. It cant be applied if the production cant be
measured in suitable units.
It can be seen that the crux of this method is to decide the time required to complete a piece.
The fixation of this time should be done in such a way that within that much time, a normal
worker can complete the piece. This can be done either on the basis of previous experience or
on the basis of time and motion study.
Labour Cost
255
(b)
Piece Rate With Guaranteed Time Rate :
Under the straight piece rate system, the remuneration of a worker depends upon the production
achieved. If the production is less due to some factors beyond his control, he is likely to be
penalised. To remove this difficulty, it may be decided that he will be paid on time rate if his
piece rate earnings fall below time rate earnings, so that the worker is assured of minimum
earnings on time basis. However, if this guaranteed time rate payment is too high, the incentive
to increase output to get piece rate payment is less.
(c)
Differential Piece Rate System :
Under this system, higher rewards are guaranteed to more efficient workers. The piece rates
are fixed in such a way that normal piece rate is paid for work performed within and upto the
standard level of efficiency. If efficiency exceeds the standard, payment at higher piece rate is
made.
This can be illustrated as below :
Normal Piece Rate.
10% above normal piece rate.
Above 100% efficiency
30% above normal piece rate.
This method offers more inducement to the workers to work more efficiently and earn higher
wages. But it is complicated to understand and expensive to operate.
Following systems use this principle of differential piece rates.
(1)
Taylor Differential Piece Rate System :
This was introduced by F.W. Taylor. It provides two piece rates, a low piece rate for output
below standard and a high piece rate for output above standard and does not provide for any
guaranteed time rate payment. Eg. If standard output is 10 units and piece rate is Re.l per
unit, the total wages are :
(i)
If actual hourly output is 8 units i.e. below standard, the piece rate is say 80% of normal
piece rate i.e. Re. 0.80. Hence total wages are 8 units x Re. 0.80 = Rs.6.40.
(ii)
If actual hourly output is 12 units i.e. above standard, the piece rate is say 120% of
normal piece rate i.e. Rs. l.20.
Hence, total wages are 12 units x Rs.l.20 = Rs. 14.40.

The basic defect with this system is that eventhough the efficiency of the worker is below
standard even marginally, he is punished heavily and even though the efficiency of the worker
is above standard even marginally, he is benefited to a very great extent.
256
(2)
Merrick Differential Piece-rate System :
To remove the defect existing in case of Taylors System which heavily punishes the worker
who produces below standard, the Merrick System provides for three piece rates Eg.
Efficiency
Piece rate
Up to 83%
Normal
Up to 100%
110% of normal piece rate
Above 100%
130% of normal piece rate
It should be noted that under this method also, no guaranteed time rate payment is provided.
Illustration :
The following particulars relate to a company.
Piece Rate
6 paise per unit. Production of the workers
125 units per day
80 units per day
150 units per day
Standard production per day 120 units.

Calculate the wages of the workers on the basis of Merricks Differential piece rate system,
when basic piece rate is guaranteed below the standard and workers get 108% of the basic
piece rate between 100% and 120% of the basic piece rate above 120% efficiency.
Solution :
Calculation of total wages :
(a)
Worker M :
Actual production 125 units i.e. 104% efficiency.
Applicable piece rate - 108% of normal i:e. 6.48 paise per unit.
Total wages : 125 units x 6.48 paise = 810 paise i.e. Rs. 8.10
(b)
Worker N :
Actual production 80 units i.e. below the standard.
Applicable piece rate : basic piece rate i.e. 6 paise per unit
Total wages : 80 units x 6 paise = 480 paise i.e. Rs. 4.80
Labour Cost
257
(c)
Worker O :
Actual production 150 units i.e. 125% efficiency.
Applicable piece rate - 120% of normal i.e. 7.20 paise per unit.
Total wages 150 units x 7.20 paise = 1080 paise i.e. Rs. 10.80
(3)
Gantt Task Bonus System :
This system is a combination of time rate and piece rate and provides for minimum time rate
payment. A high task or standard is set. The wage structure may be fixed as below.
Output below standard
Minimum time rate payment.
Output at standard
Time wages plus some increase in wage rates.
Output above standard
High piece rate for entire output.
(C)
Individual Incentive Systems :
In case of time rate systems, the losses due to inefficiency of workers or benefits due to
efficiency of workers are suffered or enjoyed by the employer alone. Similarly in case of piecerate systems, the losses due to inefficiency of workers or benefits due to efficiency of workers
are suffered or enjoyed by the worker alone. (The employer may be indirectly affected in the
form of increased or decreased per unit overheads.) The incentive systems differ from both
these systems in such a way that the financial advantages arising out of the efficiency of
workers are enjoyed by both employer as well as workers. There are various systems by
which the incentive may be paid to workers. We will consider following main systems.
(a)
Halsey Premium System :
Under this system, if the actual time taken is equal to or more than standard time, worker is
paid at the time rate. If actual time is less than standard time, the worker, in addition to time
wages for hours actually worked, gets a bonus payment. The bonus is equivalent to the wages
for the time saved in the decided percentage to be shared with the employer The percentage
allowed to worker may vary from 30% to 70% (usually 50%). The total wages payable to the
worker under this system, can be computed as below.
AH X HR
Where -
258
(SH - AH) X HR
AH
Actual hours
SH
Standard hours
HR
Hourly rate
Assuming 50% - 50% sharing
(b)
Halsey - Weir Premium System :
This system is a deviation of Halsey Premium System only with the exception that the ratio of
sharing between the worker and the employer is fixed as 1/3 : 2/3. The computation of total
wages is the same as in case of Halsey Premium System, except the change in this ratio.
(c)
Rowan Premium System :
Under this system also, guaranteed time rate payment is made. The amount of bonus paid is
a percentage of hourly rate which is in proportion to the time saved. The total wages payable
to the workers under this system can be computed as below :
AH X HR
Where
SH - AH
SH
AH
Actual Hours
SH
Standard Hours
HR
Hourly Rate
X AH X HR
Comparative study of Halsey and Rowan System :

Comparative study of total wages under both these systems reveals that if time saved is less
than 50% of the standard time. Rowan system assures more wages than those under Halsey
system. But if time saved exceeds 50% of the standard time, Halsey system proves to be
more beneficial. In Rowan System a less efficient worker gets the same bonus as a more
efficient worker. As such Rowan System may be implemented in case of loose fixation of
standards. The fall in bonus as time saved increases, offsets the damage done by loose
standards.
Illustration :
The following are the particulars given to yon.
Standard time
.. 10 hours.
Time rate
.. Re. 1 per hour.
Prepare a comparative table under Halsey Premium System and Rowan Premium System, if
time taken is 9 hours, 8 hours, 6 hours, 5 hours 4 hours and 3 hours. Also calculate the
amount of total wages and labour cost per hour under two methods. What conclusions do you
draw from the table.
Labour Cost
259
Solution :
Hours
taken
Halsey Premium system

Wages = Actual Hours x Hourly rate
+ 1/2 (Time Saved x Hourly rate)
Rowan Premium system.

Wages = Actual Hours x Hourly rate
+ Time Saved/Time Allowed Actual Hours
x Hourly rate
(a)
Wages = 9x1+1/2 (I x 1)
= Rs. 9.50
Wages = 9 x 1 + 1/10 x 9 x 1
= Rs. 9.90
(b)
Wages = 8x1+1/2 (2 x 1)
= Rs. 9
Wages = 8 x 1+ 2/10 x 8 x 1
= Rs. 9.60
(c)
Wages = 6x1+1/2 (4 x 1)
= Rs. 8
Wages = 6 x 1 + 4/10 (6 x 1)
= Rs. 8.40
(d)
Wages = 4 x 1 1/2 (6 x 1)
= Rs. 7.00
Wages = 4 x 1 + 6/10 (4 x 1)
= 6.40
(e)
Wages = 3 X l+ 1/2 (7 x 1)
= Rs. 6.50
Wages = 3 x 1 + 7/10 (3 x 1)
= Rs. 5.10
Conclusion :
It can be concluded from the above table that so long as time saved is less than 50% of
standard time, the total wages are more under Rowan Premium system than under Halsey
Premium System. If the time saved is more than 50% of standard time, Halsey system proves
to be more beneficial in terms of the total wages.
The other systems for making the payment of premium can be briefly described as below.
(a)
Barth Premium System :
Under this system, the wages payable to the workers are computed as below.
Wages = Hourly Rate x
Standard Hours x Actual Hours
Eg. Standard Hours are 10

Actual hours are 8
Hourly rate is Rs. 2 per hour.
Total wages will be
2x
10x8
= Rs. 17.89
260
It should be noted that this system does not provide for any guaranteed time wages. This
system is suitable for beginners or apprentices.
(b)
Emersonss Efficiency Bonus System :
Under this system the wages payable to the workers are computed as below.
Wages
Actual Hours x Hourly Rate

+ Bonus Percentage x Actual -Hours x Hourly rate.
For calculating bonus percentage, following directions are provided.

Efficiency
Bonus
(1) Below 66.2/3 %
No bonus is payable. Only the guaranteed time

wages are payable.
(2) 66.2/3% to 100%
In Addition to time wages, bonus is paid at different percentages

increasing rapidly to 20% at 100% efficiency.
(3) Above 100 %
In addition to time wages and bonus @ 20%, 1% bonus for

each 1% increase in efficiency beyond 100% is paid.
Eg. 101 % efficiency - 21 % Bonus
110 % efficiency
- 30 % Bonus
120 % efficiency
- 40 % Bonus & so on.
The efficiency percentage can be calculated as below.

(1)
On time basis :
Standard Hours
Actual Hours
(2)
x 100
On output basis :
Actual output
Standard output
x 100
Eg. Standard Hours are 10

Actual Hours are 8
Hourly Rate is Rs. 2 per hour.
Labour Cost
261
Efficiency percentage will be as below.

Standard Hours
Actual Hours
X 100 =
10
8
X 100 = 125%
Bonus percentage will be 45%

Total Wages
= 8 x 2+ 45% of 8 x 2
= 16 + 45% of 16
= 16 + 7.20
= Rs. 23.20
It can be seen that the abovestated system is similar to that of piece rate with guaranteed
time rate. This system may be suitable for non efficient workers for improving their efficiency.
(c)
Bedaux Point System :
Under this system, the standard time is divided into standard minutes, each standard minute
identified as Bedaux Point or B. The wages payable to the worker are computed as below.
Wages = Actual Hours x Hourly Rate +
75 % of BS x Hourly Rate
60
Where BS indicates the number of Bs saved i.e. the difference between Bs earned and
standard Bs allowed for the job.
Eg. Standard points for a job - 400 points in 8 hours.
Hourly Rate - Rs. 3 per hour.
Wages
75% of (450 - 400) x 3
8x3+
24 + 75% of 2.50
24 + 1.875
Rs. 25.875.
60
It should be noted that a very accurate system of work study is required for this system. It is
difficult to understand and involves a lot of clerical efforts.
262
(d)
Accelerating Premium System :
Under this system, incentive increases at a fast rate with the increase in output. Total wages
payable to the worker are computed as below.
Y = 0.8 X2 where
Y = Earnings
X = Efficiency.
i.e. If efficiency is 140%, the earnings will be :

0.8 x 140 x 140
100 100
x 1.568 of basic wages i.e.
100% wages, 56.8% bonus.

Eg. Standard hours are 10
Actual Hours are 8
Hourly rate is Rs. 2 per hour.
Efficiency percentage will be
10/8 x 100 = 125%

Earnings = 0.8 x
125
125
x
100
100
= 1.25
Earnings will be 125% of basic wages i.e 100% basic wages, 25% bonus.
Basic, wages
8x2
= 16
Bonus
25% of Rs. 16
=4
Total Wages
= 20
This system is very difficult to understand.

(e)
Baum Differential Plan :
This is a combination of Taylors differential piece rate system and Halsey system and is also
known as Milwaukee Plan.
Labour Cost
263
(f)
Diemer System :
This is a combination of Halsey System and Gantt system.

(D)
Group Incentive System :
In many cases, the output of the individual workers cannot be measured though the output of
a group of workers can be measured. In such cases, the individual time rates or in some
specified proportion depending upon the skill of the workers or equally, can be applied.
(E)
Indirect Monetary Remuneration :
This may take the following two forms.

(a)
Profit Sharing :
According to this method, the workers, are entitled to share in profits earned by an
organisation, in addition to the regular wages, at a specified percentage. The legal
provisions in this regard are enacted by way of Payment of Bonus Act, 1965. According
to the provisions of this Act, all the employees drawing a monthly remuneration of
Rs. 2,500 or less are entitled to a bonus at the minimum rate of 8.33% of wages of the
subject to the maximum ceiling of 20 % of the wages. It should be noted that the statutory
requirement of the payment of bonus does not depend on the profit earned necessarily,
as the bonus is payable eventhough there are no profits. It is also worth noting that the
statutory requirement of payment of bonus is the specific percentage of the wages or
salaries paid to the workers and hence remains unaffected by any changes, either upwards
or downward, in the profits earned by the organisation.
(b)
Co-partnership :
According to this method, the workers are granted ownership rights in the operations of
the organisation by which the workers are in the position to control the affairs of the
organisation. In corporate organisations, it may be in the form of offering the shares of
the company to the workers or granting of loans to the workers to buy companys shares,
according to which the workers get the voting rights to control the affairs of the company.
The workers get dividend on the shares as bonus. With the help of this method, the
morale of the workers is increased. However, certain objections are raised against this
method. First, the increase in earnings is too small. Second, the shareholding of the
workers is too small to control the affairs of the company. Third, the workers are not
rewarded according to the individual efficiency.
264
(F)
Non-monetary Incentives :
The intention of these incentives is to attract better workers, retain the existing workers,
encourage loyalty, reduce labour turnover, provide better working conditions to workers and so
on. Various benefits as stated below may be granted to the workers, either free or at reduced
rates, remaining amount being contributed by the workers.
(1)
Health and safety services.
(2)
Education and training to workers and their children.
(3)
Canteen facility.
(4)
Pension, superannuation fund etc.
(5)
Loans at reduced rate of interest.
IMPORTANT TERMS IN CASE OF LABOUR COST :

(A)
Labour Turnover :
In every business organisation, the process of employees leaving the organisation and new
workers being recruited is a normal feature. Labour Turnover indicates this change in labour
force showing a highly increasing trend or highly decreasing trend. Labour turnover showing
sharp increasing trend may involve the reduction in labour productivity and increasing costs.
Too low a labour turnover trend may be due to inefficient workers who would not like to leave
the organisation.
Causes of labour turnover :
The causes of labour turnover can be broadly classified as below :
(a)
(b)
Avoidable causes :
(1)
Dissatisfaction with job.
(2)
Dissatisfaction with remuneration.
(3)
Dissatisfaction with working conditions.
(4)
Dissatisfaction with hours of work.
(5)
Relationship with supervisors and workers.
Unavoidable causes :
(1)
Betterment/Personal.
(2)
Illness or accident.
(3)
Move from locality.
Labour Cost
265
(4)
Discharge.
(5)
Marriage.
(6)
Retirement.
(7)
Death.
(8)
National service.
Costs of labour turnover

The cost of labour turnover may be classified under two headings.
(a)
Preventive Costs :
These refer to all the costs which may be incurred by the organisation to keep
workers happy and discourage them from leaving the job. This, in turn, may include the
costs like :
(b)
(1)
Cost of Personnel Administration - To maintain good relations with the workers.
(2)
Cost of medical services- To keep the workers and their families in healthy condition,
as healthy workers are assets for the organisation who contribute towards higher
efficiency and productivity.
(3)
Costs of welfare activities - To give facilities like transport, canteen etc.
(4)
Other incentive schemes like pension, provident fund, superannuation fund, Bonus
etc.
Replacement Costs :
These refer to the costs incurred for recruitment and training of new workers and the
resulting losses, wastages and reduced productivity due to the inefficiency and
inexperience of new workers.
This in its turn may include the costs like-
266
(1)
Inefficiency of new workers.
(2)
Cost of selection and placement.
(3)
Training costs.
(4)
Loss of output due to delay in getting new workers
(5)
Increased spoilage and defectives.
(6)
Cost of tools and machine breakages.
Measurement of labour turnover :

There are three methods for measuring the labour turnover.
(1)
Separation Method
Under this method, it is computed as :
No. of Separations in a period
Average no. of workers
(2)
X 100
Replacement Method
Under this method, it is computed as
No. of Replacements in a period
Average no. of workers.
(3)
X 100
Flux Method
Under this method, it is computed as No. of separations + No. of replacement
Average no. of workers
X 100
Illustration :
From the following data given by Personnel Department, calculate the labour turnover rate by
applying :
(a)
Separation Method
(b)
Replacement Method
(c)
Flux Method
No. of workers on pay-roll
- At the beginning of the month
- At the end of the month
900
1,100
During the month, 10 workers left, 40 persons were discharged and 150 workers were recruited.
Of these 25 workers are recruited in the vacancies of those leaving while the rest were for an
expansion scheme.
Labour Cost
267
Solution :
Calculation of Labour Turnover
(1)
Separation Method
No. of separations in a period
X 100
Average No. of workers

=
50
X 100 = 5
1000
Monthly Turnover Rate : 5%

Annual Turnover Rate : 5 X
(2)
365
30
= 60.83%
Replacement Method :
No. of replacements in a period
X 100

=
25
1000
X 100 = 2.5%
Monthly turnover Rate : 2.5%

365
Annual Turnover Rate : 2.5
(3)
30
30.42%
Flux Method :
No. of separations + No. of replacements
=
50 +25
= 100
X 100
7.5%
1,000
Monthly Turnover Rate : 7.5%
365
Annual Turnover Rate : 7.5 X
268
30
= 91.25%
Working Notes :
Average number of workers is calculated as No. of workers at beginning + No. of worker at end
2
=
=
(B)
900 + 1,100
2
1,000
Idle Time :
It indicates the time for which wages are paid to the workers but during which no production is
obtained. To exercise proper control on idle time, causes of the same should be analysed
properly and studied from its controllability point of view.
The causes of idle time can be analysed as below :
(a)
Productive causes :
These can be further classified as :
(i)
Due to machine breakdown.
(ii)
Power failures.
(iii) Waiting for tools, work or raw materials.

(iv)
Waiting for instructions.
These causes are supposed to be controllable causes and can be controlled if planned
properly.
(b)
Administrative causes :
Some idle time may be caused due to administrative decisions. E.g. the organisation is
having excess machine capacity or during the depression period, it is not having sufficient
work to be performed, but it has decided not to get rid of trained workers temporarily. As
such cost of idle time is accepted.
(c)
Economic causes :
Economic causes may be of seasonal nature, cyclical nature or industrial nature. E.g. if
the product manufactured is of a seasonal nature, for other periods of the year, the
capacity may remain unused, unless some other product to take care of slack season is
introduced. In case it is not possible to make alternate use of such idle capacity, some
Labour Cost
269
idle time is unavoidable. In case of cyclical causes, the causes are similar to seasonal
fluctuations but these causes are beyond the control of management.
Treatment of idle time cost :
If Idle time payment is normal and controllable, it should be classified as overheads. If it is
possible to allocate the same to some department, it should be allocated and absorbed in the
production department cost.
If idle time is normal and uncontrollable, the labour rates should be suitably modified. E.g. if
time attended is 8 hours but time booked is only 7.5 hours and labour cost is Rs. 1.5 per hour,
the hourly labour rate should be computed as 8 hours X Rs. 1.5
i.e. Rs. 1.60
7.5 hours
If idle time payment is uncontrollable and abnormal, it should not be considered as a part of
manufacturing cost but should be written off to Costing Profit and Loss Account.
(C)
Internal Control Problems in Labour Cost :
In todays world, labour is one of the most important factors of production, and contributing to
a very great extent to the cost of production. As such, it will be the intention of every organisation
to have proper control on the labour cost. The implementation of various Internal Control
Procedures indicate the following of all those methods and procedures which ensures fluent
and smooth running of the operations of the organisation and also of achieving protection of
assets, prevention of errors and frauds, proper recording of information whenever necessary.
The cost of labour may be high due to the various reasons stated below :
(1)
Excess staffing - Having more staff than the requirement.
(2)
Lack of experienced and efficient personnel.
(3)
Excessive remuneration pattern - Settlement of the wage rates or piece rates on higher
side which may not be justified on the basis of efficiency of workers.
(4)
Clerical errors or fraudulent practices taking place in the area of time keeping, computation
of wages payable, procedure for payment of wages to the workers etc.
(5)
Idle time or unusual overtime wages.
(6)
Increase of spoilage due to lack of proper supervision and inspection.
(7)
High labour turnover.
After locating the reasons for increasing labour costs, attempts can be made to keep the
same in control after following various internal control measures as discussed below.
270
(1)
To avoide the problem of excess staffing, the employment of the workers should be
made only after the receipt of labour placement requisition from the concerned department.
After the receipt of this requisition, it should be seen, whether it is possible to meet the
requirement of said department with the help of existing staff only or at least by transferring
the existing excess staff in other departments. Before proceeding with the actual process
of selection of the staff, care should be taken to decide in advance about the nature of
work which may be assigned to the individual employee.
(2)
To ensure that correct personnel is employed to work in the correct places, care should
be taken to analyse the requirements of the job and then to select the personnel which
suits these requirements. This process may be in the form of job evaluation.
Selection of the proper personnel may not be enough. To train the selected personnel to
extract maximum of their efficiency is equally necessary.
(3)
The problem of setting the excessive rate structure in the form of higher time rate or
piece rates or bonus rates may be avoided by setting the standards in the most scientific
manner. For this purpose, the techniques like time and motion study, work study etc.
may be implemented.
(4)
To avoid the clerical errors or fraudulent practices in the areas of wage sheet preparation
or wage payments, proper internal check procedures may be implemented, so that the
work of one person is properly checked by another person. For this, following steps may
be taken :
(a)
Time recording clock should be installed, wherever possible. Proper supervision is

required to ensure that one person punches his own card only.
(b)
The terms of remuneration should be set and made known to the workers in very
very clear terms.
(c)
Proper internal checks should be executed while preparing the wages sheets.
Cashier should not be allowed to handle the wages sheets and the person preparing
the sheets should not be allowed to prepare wage packets. Personnel officer/manager
should check and authorize the wages sheets.
(d)
The wages should be paid to workers after they are properly identified. The wages
should not be paid to any other person, unless proper authorization letter is produced
in exceptional circumstances.
(e)
Distribution of wages should be made in all the departments at a time so as to

avoid the possibility of one person being present at two places.
Labour Cost
271
(5)
Existence of idle time should be properly analyzed according to controllability. The causes
of controllable idle time should be attempted to be avoided.
If it is necessary to work overtime, it should be properly authorized and should be paid
and accounted for properly. Care should be taken to see that proper returns are obtained
for making overtime wages payment.
(6)
If the labour cost is higher due to spoilage of work which in turn may be due to lack of
proper supervision or inspection, it is a cost which can very will be controlled by having
proper supervision or inspection.
(7)
The causes of labour turnover should be analysed according to normality. All the avoidable
causes of labour turnover should be paid proper attention. Higher trend of labour turnover
adds to the costs in two ways mainly. It reduces the labour productivity and at the same
time, increases the costs. If the workers have the grievances which are of avoidable
nature, say dissatisfaction with remuneration or other benefits or working hours or working
conditions or job itself or relations with the fellow workers or the supervisors, attempts
can be made to avoid those causes of labour turnover.
(1)
The standard hours for job X is 100 hours. The job can be completed by A in 60 hours, by
B in 70 hours and by C in 95 hours.
The bonus system applicable to the job is as follows :
% of time saved to time allowed
Bonus
Saving upto 10%
10% of time saved
Saving from 11% to 20%
15% of time saved
20% of time saved
25% of time saved.
Rate of pay per hour is Rs.1 Calculate the total earnings of each worker and also the
rate of earnings per hour.
272
Solution :
A
100
100
100
(1)
Standard Hours
(2)
Actual Hours
60
70
95
(3)
Hours Saved
40
30
(4)
% Hours saved
40%
30%
5%
(5)
Applicable bonus rate

20%
20%
10%
60
70
95
40
30
0.5
68
76
95.5
(% of wages for time saved)

(6)
Hourly Rate (Rs.)
(7)
Basic wages (Rs.) - 2 x 6

i.e. Actual Hours x Hourly rate
(8)
Wages for time saved (Rs.) - 3 x 6

i.e. Hours Saved x Hourly Rate
(9) Bonus (Rs.) - 8 x 5

i.e. Wages for time saved x Bonus Rate
(10) Total - (Rs.) 7+ 9
Note :
It is assumed that the amount of bonus is not decided on rates of bonus on cumulative basis.
(2)
During one week X makes 200 units. He receives wages for a guaranteed 44 hours per
week at a rate of Rs. 1.50 per hour. Estimated time to produce one unit is 15 minutes.
Time allowed is increased by 20% allowance on estimated time, under incentive scheme.
Calculate earnings as per :
(i)
Time rate
(ii)
Piece rate
(iii) Rowan scheme

(iv)
Halsey scheme
Solution :
(i)
Time Rate :
No. of Hours X Hourly Rate
= 44 Hours x Rs. 1.50 = Rs. 66
Labour Cost
273
(ii)
Piece Rate :
Hourly Rate
Units produced
X
Units per hour
200 units X
Rs. 1.50
4 units
= Rs. 75
(iii) Rowan Scheme :

Actual Hours X Hourly Rate +
Time Saved
X Actual Hours X Hourly rate
Time Allowed
44 Hours x Rs. 1.50 +
Rs. 66 + Rs. 17.60
Rs. 83.60
16 Hours
60 Hrs
X 44 Hours X Rs. 1.50
(iv) Halsey Scheme :

Actual Hours X Hourly Rate + 1/2 (Time Saved X Hourly Rate)
=
44 Hours X Rs. 1.50 + 1/2 (16 Hours X Rs. 1.50)
Rs. 66 + Rs. 12
Rs. 78
Working Notes :
For incentive scheme, time allowed is increased by 20% of estimated time
Estimated time is 15 minutes per unit
For incentive scheme, time allowed will be -
15 minutes + 20% = 18 minutes

Time allowed for 200 units will be 18 minutes
X
200 units = 60 Hours
60 minutes
Actual time taken is 44 Hours.
Hence, time saved will be 16 hours ( i.e. 60 hours - 44 hours)
274
It is assumed that the allowance of 20% is available only in case of incentive systems
and not in case of time rate or piece rate systems.
(3)
In a factory under bonus system, bonus hours are credited to the employee in the
proportion of time taken which time saved bears to time allowed. Jobs are carried forward
from one week to another. No overtime is worked and payment is made in full for all units
worked on, including those subsequently rejected. From the following information, you
are required to calculate for each employee.
(1)
Bonus hours and amount of bonus earned.
(2)
Total wages cost.
(3)
Wage cost of each unit (good) produced.
Employee
Basic wage rate per hour
Rs. 5
Rs. 8
Rs. 7.5
Units issued for production
2,500
2,200
3,600
Time allowed for 100 units
2H 36M
3H
1H 30M
Time taken
52H
75H
48H
Rejections
100 units
40 units
400 units
Solution :
The description of the bonus system indicates that it is Rowan system of incentive payment.
A
(1)
Time allowed for 100 units
156 min.
180 min.
90 min.
(2)
Units issued for production
2,500
2,200
3,600
(3)
Time allowed for actual production
65 hours
66 hours
54 hours
(4)
Time taken
52 hours
75 hours
48 hours
(5)
Time saved i.e. 3-4
13 hours
6 hours
(6)
Hourly basic wage rate (Rs.)
7.5
(7)
Basic wages i.e. 4 x 6 (Rs.)

260
600
360
52
40
312
600
400
Time taken x Hourly rate

(8)
Bonus earned : (Rs.)

Time
Hourly
X
taken
(9)
Time saved
X
rate
Time allowed
Total wages i.e. 7 + 8 (Rs.)
Labour Cost
275
100
40
400
2,400
2,160
3,200
Re. 0.13
Re. 0.28
Re. 0.125
(10) Rejections (units)

(11) Good units i.e. 2-10
(12) Wages per good unit i.e. 9/11
(4)
From the following particular, you are required to work out the earnings of a worker under.
(a)
Straight Piece Rate
(b)
Differential Piece Rate
(c)
Halsey Premium Scheme (50% Sharing)
(d)
Rowan Premium Scheme
Weekly working hours
48
Hourly wage rate
Rs. 7.50
Piece Rate per unit
Rs. 3.00
Normal time taken per piece
20 minutes
Normal output per week
120 pieces
Actual output for the week
150 pieces
Differential piece rate
80% of piece rate when output below normal and

120% of piece rate when output above normal.
Solution :
(a)
Straight Piece Rate :

Actual output x piece rate per unit
(b)
150 pieces x Rs. 3
Rs. 450
Differential Piece Rate :

Actual output is more than normal output. Hence, piece rate will be 120% of normal
piece rate.
Applicable piece rate 120% of Rs. 3 i.e. Rs. 3.60
Wages = Actual output x Applicable piece rate per unit
= 150 piece x Rs.3.60
= Rs. 540
276
(c)
Halsey Premium Scheme :

(Time Saved x Hourly Rate)
Actual Hours X Hourly Rate +
(d)
48 hours X Rs. 7.50 +
Rs. 360 + Rs. 15/2
Rs. 367.50
2
2 hours X Rs. 7.50
2
Rowan Premium Scheme :

Time Saved
Actual Hours x Hourly Rate +
X Actual Hours X Hourly Rate
Time Allowed
2 hours
=
48 hours X Rs.7.5 +
X 48 hours x Rs. 7.50

50 hours
Rs. 360 + Rs. 14.40
Rs. 374.40
Note :
Time saved is calculated as below :
Normal time per piece
20 minutes
Pieces per hour
Pieces produced
150
Hours allowed for pieces produced
50
Actual hours taken
48
Hours saved
i.e. 150/3
(5)
In an engineering workshop, 15 persons work in a group. If the weekly production of the

group exceeds 120 units per hour (which is standard), each man gets a bonus in addition
to his hourly earnings.
Bonus regulation - Each workers share should be 1/2 of the percentage in excess of
standard production. The bonus shall be payable at this percentage of wage rate Rs.1.50
per hour. There is no relationship between individual workers hourly rate and bonus rate.
Labour Cost
277
The following is a weekly output :

Day
Hours worked
Output in units
Monday
150
24,700
Tuesday
160
25,500
Wednesday
145
17,060
Thursday
155
18,050
Friday
170
28,900
Saturday
160
21,150
940
1,35,360
Compute
a.
The rate and amount of bonus for the week.
b.
Total earnings of David who worked 40 hours during the week and his basic wage was
Rs. 1.20 per hour and that of Abdulla who worked for 48 hours and his basic wage was
Rs. 1.25 per hour.
Solution :
(a)
Actual Production for the week
1,35,360 units
Standard production i.e. 940 x 120
1,12,800 units
Excess Production
22,560 units
22,560
Excess production percentage =
X 100
= 20%
1,12,800
Bonus percentage for the group
= 1/2 of 20%
= 10%
Bonus Rate
: 10% of Rs. 1.50

= Re. 0.15 per hour
278
(b)
(1) Total Earnings of David :

Basic wages - 40 hours x Rs. 1.20 hours
Rs. 48.00
Bonus - 40 hours x Re. 0.15/hour
Rs. 6.00
Rs. 54.00
(2)
Total Earnings of Abdulla :

Basic wages - 48 hours x Rs. 1.25/hour
Rs. 60.00
Bonus - 48 hours x Rs. 0.15/hour
Rs. 7.20
Rs. 67.20
(6)
Two fitters, a labourer and a boy, undertake a job on piece rate basis for Rs. 1,290. The
time spent by each of them is 220 ordinary working hours. The rates of pay on time rate
basis are Rs. 1.50 per hour for each of the two fitters. Re. 1 per hour for the labourer and
Re. 0.50 per hour for the boy. Calculate :
(a)
The amount of piece-work premium and the share of each worker, when the piece
work premium is divided proportionately to the wages paid.
(b)
The selling price of the above job on the basis of following data - Cost of Direct
Materials is Rs. 2,010, works overhead at 20% of Prime Cost, selling overhead at
10% of works cost and Profit at 25% of cost of sales.
Solution :
(A) (1)
wages payable on time basis

Fitter
220 hrs. x 2 x Rs. 1.50
= Rs. 660
Labourer
220 hrs. x Re. 1
= Rs. 220
Boy
220 hrs. x Re. 0.50
= Rs. 110
Basic Wages
= Rs. 990
(2)
Price of the job
Rs. 1,290
(3)
Premium received i.e. b - a
(4)
Share of each worker Fitters
Rs. 300
Rs. 990
Labour Cost
Rs. 300
Rs. 660
Rs. 200.00
279
Labourer
Rs. 300
Rs. 990
Rs. 300
Rs. 990
Boy
Rs. 220
- Rs. 66.67
Rs. 110
- Rs. 33.33
Rs. 300.00
(b)
Fixation of selling price :

Cost of Direct Material
Rs. 2,010.00
Cost of Labour
Rs. 1,290.00
Prime Cost
Rs. 3,300.00
Works Overheads
(20% of Prime Cost)
Works Cost
Rs. 660.00
Rs. 3,960.00
Selling Overheads
(10% of works cost)
Cost of Sales
(7)
Rs. 396.00
Rs. 4,356.00
Profit (25% on cost of sale)
Rs. 1,089.00
Selling Price
Rs. 5,445.00
A worker, whose daily work wages is Rs. 2.50 an hour, received production bonus under
the Rowan scheme. He carried out the following works in a 48 hours week.
Job 1
1,500 items at 4 hours per 1000
Job 2
Job 3
Job 4
1,500 items for which no Standard time was fixed and it was arranged that
the worker would be paid a bonus of 25%. Actual time taken on the job was
4 hours.
Job 5
2,000 items at 8 hours per 1000, each item was estimated to be half finished.
Job No. 2 was carried out on a machine running at 90% efficiency and an extra allowance
of 1/9th of actual time was given to compensate the worker.
280
4 hours were lost due to power cut. Calculate the earnings of the worker, clearly stating your
assumptions for the treatment given by you for the hours last due to power cut.
Solution :
(a)
Calculation of time allowed

Job 1
6 hours
Job 2
6 hours
Job 3
54 hours
Job 4
5 hours
Job 5
8 hours
79 hours
(b)
Time taken
44 hours
(Except idle time)

(c)
Time saved
35 hours
(d)
Total wages (As per Rowan system)

Time saved
Time taken X Hourly rate +
X Time taken X Hourly Rate

Time allowed
(e)
44 hours X Rs. 2.50 +
Rs. 110 + Rs. 48.73
Rs. 158.73
35 hours
79 hours
X 44 hours X Rs. 2.50
Idle time wages (At hourly rate)

4 hours X Rs. 2.50
=
(f)
Rs. 10
Total earnings - i.e. d + e

Rs.158.73 + Rs. 10.00
=
Rs.168.73
Labour Cost
281
Note :
(1)
The idle time is not treated for computing time taken. For idle hours, the worker will get
the wages at normal hourly rate.
(2)
Time allowed for Job 2, Job 4 and Job 5 is calculated as below :

(a)
(b)
Job 2 :
Time taken for 1,800 units
5.40 hour
Add :Extra allowance 1/9
0.60 hour
Time allowed
0.60 hour
Job 4 :
Time taken for 1500 units
4 hours
Add : Allowance @ 25
1 hour
Time allowed
(c)
5 hours
Job 5 :
Time taken for 2000
16 hours
Each item half finished

Equivalent finished units
1,000
Time for equivalent finished units
8 hours
QUESTIONS
282
1.
Explain the various steps in the process of identifying the direct labour cost with the
individual cost center.
2.
What do you mean by idle time. Explain in details the cost accounting treatment of idle
time.
3.
Explain the term Labour Turnover. What are the causes responsible for labour turnover?
Explain the costs of labour turnover. How the Labour turnover is measured?
PROBLEMS
(1)
(2)
During the first week of March, 1984 the workman Mr. Saurabh manufactured 300 articles.
He receives wage for a guaranteed 48 hours week at the rate of Rs. 4/- per hour. The
estimated time to produce one article is 10 minutes and under incentive scheme the
time allowed is increased by 20%. Calculate his gross wages according to :
(a)
Piece work with guaranteed weekly wage.
(b)
Rowan premium bonus and
(c)
Halsey premium bonus 50% to workman.
Calculate total monthly remuneration of three workers A, B and C from the following
data.
(a)
Standard production per month per worker 1,000 units.
(b)
Actual production during the month

A - 850 units, B - 750 units, C - 950 units.
(c)
Piece rate is Re. 0.10 per unit.
(d)
Additional production bonus is Rs. 10 for each percentage of actual production

exceeding 80% over standard.
(Example 79% Nil, 80% - Rs. 10, 81% - Rs. 20 and so on)
(e)
(3)
Dearness allowance fixed Rs. 60 per month.
Following are the particulars as regards a worker who worked on jobs No. 122 and 133.
Job No.
Time allowed
Time taken
122
26 hours
20 hours
133
26 hours
30 hours
His normal and basic rate of wages was Rs. 28 per day of 8 hours and the dearness
allowance was Rs. 42 per week of 48 hours.
Calculate the amount payable to him by showing your workings on the following basis.
(a)
Time basis.
(b)
Halsey Incentive Plan basis (Bonus at 50% of time saved)
(c)
Rowan Incentive Plan basis.
Labour Cost
283
(4)
Standard time fixed for a job is 40 hours and time rate is Rs. 4 per hour. You are required
to prepare a comparative table under Halsey Plan 50 - 50 and Rowan Plan, if actual time
taken is 36 hours, 32 hours, 24 hours, 16 hours and 12 hours.
The table should clearly show (a) Bonus payable, (b) Total earnings, (c) Effective rate of
earnings per hour.
(5)
Calculate the earnings of a workman under Halsey Premium Plan and Rowan Premium
Plan for executing a piece of work in 60 hours as against 75 hours allowed. His hourly
rate is 25 paise and under Halsey system, he is to be paid bonus at 50% of time saved.
In addition, he gets a dearness allowance for Re. 1 per day of 8 hours worked.
(6)
From the following information, calculate the earnings of A, B and C under Halsey and
Rowan premium bonus plans.
A
35
40
42
Wages per unit of output
Rs. 2
Rs. 3
Rs. 4
Wage rate per hour
Rs. 7
Rs. 8
Rs. 10
Actual hours taken
50
48
46
200
150
125
Standard time in hours per 100 units
Actual no. of units produced
(7)
The firm employs 5 workers at an hourly rate of Rs. 2.00. During the week they worked
for 4 days for a total period of 40 hours each and completed a job for which standard time
was 48 hours for each worker.
Calculate the labour cost under the Halsey Method and Rowan Method of incentive Plan
Payments.
(8)
Compute the total time wages and total earnings of a worker, the rate earned per hour
and the bonus per hour in respect of three workers X,Y, and Z under the Halsey-Weir
bonus plans. The following are the particulars supplied.
Standard Time
: 20 hours.
Hourly Rate of Wages
: Re. 1.00 per hour.
Time Taken X = 16 hours, Y = 12 hours and Z = 10 hours.
284
(9)
The three workers Govind, Ram and Shyam produced 80, 100 and 120 pieces of a
product X on a particular day in May 1987 in a factory. The time allowed for 10 units of
Product X is 1 hour and their hourly rate is Rs. 4. Calculate for each of these three
workers the following :
(a)
Earnings for the day
(b)
Effective rate of earnings per hour under

(i)
Straight piece Rate
(ii)
Halsey Premium Bonus (50% sharing)
(iii)
Rowan Premium Bonus methods of Labour Remuneration
(10) A worker takes 6 hours to complete a job under a scheme of payment by results. The
standard time allowed for the job is 9 hours. His wage rate is Rs. 1.50 per hour. Material
cost of the job is Rs. 16 and the overheads are recovered at 150% of the total direct
wages. Calculate the factory cost of the job under - (a) Rowan and (b) Halsey scheme of
incentive payments.
(11) In an engineering concern, the employees are paid incentive bonus in addition to their
normal wages at hourly rates. Incentive bonus is calculated in proportion of time taken to
time allowed, of the time saved. The following details are made available in respect of
employees X, Y and Z for a particular week.
X
Normal Wages (Rs. per hour)
4.00
5.00
6.00
Completed units of production
6000
3000
4800
0.8 hr.
1.5 hrs.
1 hr.
42
40
48
Time Allowed (per 100 units)

Actual time taken (hours)
You are required to work out for each employee
(a) The amount of bonus earned.
(b) The total amount of wages received.
(c) The total wages cost per 100 units of output.
Labour Cost
285
(12) A workman whose basic rate of pay under Rowan plan of premium bonus is Rs. 2 per
hour. In addition, he receives a cost of living bonus of Rs. 33 per week of 66 hours on
actual hours worked. During a week, he does the following jobs.
(i) Job A for which 30 hours are allowed in 20 hours.
(ii) Job B for which 36 hours are allowed in 20 hours.
During this week, his waiting time was 4 hours.
Calculate his earnings and amount to be charged to each job.
(13) An operator engaged on a machine, receives an ordinary day rate of Rs. 1.60 per day of
8 hours. The standard output has been fixed at 80 pieces per hour (time as fixed for
premium bonus.) On a certain day, the output of a worker on this machine is 800 pieces.
Find the labour cost per 100 pieces and the wages that should have been actually
earned by the workman under the following (a) If a bonus of Re. 0.23 is paid per 100 of extra output.
(b) If paid on straight piece work basis at the standard rate.
(c) If Halsey Premium System is adopted.
(14) In a manufacturing concern, 20 workmen work in a group. The concern follows a group
incentive bonus system whereby each workman belonging to the group is paid a bonus
on the excess output over the hourly production standard of 250 pieces, in addition to his
normal wages at hourly rate. The excess of production over the standard is expressed
as a percentage and two thirds of this percentage is considered to be the share of the
workman and is applied to the normal hourly rate of Rs. 6.00 (Considered only for purpose
of computation of bonus.) The output data for a week are stated below.
Days
286
Manhours worked
Output (in pieces)
Monday
160
48,000
Tuesday
172
53,000
Wednesday
164
40,000
Thursday
168
52,000
Friday
160
46,000
Saturday
160
42,000
984
2,81,000
You are required to (a)
Work out the amount of bonus for the week and the average rate of which each workman
is to be paid the same.
(b)
Compute the total wages including bonus payable to Ram Jadhav who worked for 48
hours at an hourly rate of Rs. 2.50 and to Francis Williams who worked for 52 hours at an
hourly rate of Rs. 3.00.
(15) Following data for the month of October 1990 is available for a company.
No. of workers on payroll on 1st October, 90 - 1450
No. of workers on payroll on 31st October 90 - 1550
During the month 10 workers left the company, 70 persons were discharged and 200
workers were recruited. Of these workers, 40 workers were recruited in the vacancies of
those who had left and the remaining were recruited for an expansion programme.
Calculate the labour turnover rate by using (i)
Separation Method
(ii)
Replacement Method
(iii) Flux Melhod
Labour Cost
287
NOTES
288
Chapter 10
OVERHEAD COST
It has already been discussed that the term cost can be basically classified as Direct Cost
and Indirect Cost. Direct Cost indicates all those costs which can be identified with the
individual cost centre and indirect cost indicates all those costs which cannot be identified
with the individual cost centre. The total of indirect costs are termed as overheads.
There may be various ways in which the overheads may be classified.
(1)
Elementwise Classification :
As the cost can be basically classified as per the Elements of Cost i.e. Material Cost,
Labour Cost and Expenses, the indirect cost i.e. overheads may be classified as per the
elements of cost. This classification of overheads takes the form of :
(a)
Indirect Material
(b)
Indirect Labour
(c)
Indirect Expenses.
The meaning and the type of expenses included in this classification have already been
discussed in the chapter on Cost Sheet.
(2)
Functionwise Classification :
Under this classification, the overheads are classified according to the functions they
perform. This classification of overheads takes the form of :
(3)
(a)
Factory Overheads (also termed as production or works or manufacturing overheads)
(b)
Administration Overheads.
(c)
Selling and Distribution Overheads.The meaning and the type of expenses included
in this classification have already been discussed in the chapter on Cost Sheet.
Variabilitywise Classification :
(i)
Fixed overheads : These overheads indicate the costs which remain unaffected
by variations in volume of output. E.g. Rent, Insurance on building, salary to
Overhead Cost
289
administrative staff etc. Per unit cost of overheads may reduce as the volume of
output increases but the total overheads remain constant.
(ii)
Variable overheads : These overheads indicate the costs which vary directly in
proportion to volume of output. E.g. Consumable stores, nuts/bolts, loose tools
etc. Per unit cost of overheads remains the same but total overheads may increase
or decrease as per volume of output.
(iii) Semi-variable overheads : These overheads indicate those which are neither
fixed nor variable in nature. These may remain fixed at certain levels of activity while
may vary proportionately at other levels of activity. E.g. maintenance cost, power,
electricity, supervision cost etc.
(4)
Controllabilitywise Classification :
Under this classification, the overheads are classified according to their controllable
nature. This classification takes the form of :
(5)
(a)
Controllable overheads.
(b)
Uncontrollable overheads.This classification has already been discussed.
Normalitywise Classification :
Under this classification, the overheads are classified according to the fact as to whether
the overheads are normally incurred at a certain level of output under normal circumstances.
This classification takes the form of :
(a)
Normal overheads.
(b)
Abnormal overheads.
This classification has already been discussed.

It should be noted in this connection, that the above classification refers to the classification
of same amount of overheads in different forms to suit the individual requirements. E.g. For the
purpose of preparing the cost statement, overheads may be classified according to functions
while for the purpose of marginal costing applications, overheads may be classified according
to variability.
Procedure for Charging the Overheads :
The basic aim of costing is to find out the cost of each cost centre. The cost of each cost
centre can be either the direct cost or the indirect cost. The direct cost can be identified with
the individual cost centre and hence poses no difficulties. To charge the indirect costs i.e.
overheads to the individual cost centres is the major problem. For this, the following procedure
may be followed.
290
(A)
Allocation/Primary Apportionment :
There can be some overheads which are incurred for the company as a whole, i.e. for all the
departments. i.e. Production as well as Service departments. To identify the common costs
with the individual departments is the first stage problem. This can be solved in two ways.
(1)
If at all it is possible to identify some overheads with the individual departments they
should be identified by following the procedure of allocation of overheads.
E.g. Wages paid to the maintenance department workers can be obtained from wages
sheet and can be allocated to maintenance department. Similarly, cost of indirect material
can be allocated to individual departments by pricing material requisition slips.
(2)
It may not be possible in all the cases to allocate the overheads, i.e. in case of common
expenses for the entire factory. In this case, they can be apportioned among the various
departments on some suitable basis, i.e. to all production as well as service departments.
This process is in the form of Primary apportionment or distribution of overheads.
The selection of the base on which overheads are or should be apportioned depends on
the following principles :
(a)
Service or use basis : If the benefit obtained by various departments from the
overheads can be measured, overheads can be apportioned on that basis.
(b)
Survey basis : If amount of services rendered cant be measured, survey basis

may be applied. E.g. If it can be noted that a supervisor is giving 60% of his services
to department A and 40 % to department B, his wages can be apportioned on
that basis.
(c)
Ability to pay basis : In this case, the apportionment may depend upon the factors
like total sales/profitability. It may not be fair in some cases as most efficient
departments may have to bear higher amounts of overheads, though actual overheads
of that department may be lower than those of other departments.
The usual bases which can be selected for Primary Apportionment may be as below :
Item of expenditure
Base
(1)
Canteen expenses/Staff Supervision
Number of workers.
(2)
Rent/Taxes
Area
(3)
Power
HP/KWh
(4)
General Lighting
Number of light points/area
(5)
Depreciation
Value of assets
(6)
Supervision
Number of Employees/wages paid
Overhead Cost
291
(7)
Telephone expenses
Number of telephone calls made
(8)
Fire Insurance.
Value of stocks held/value of Assets.
Illustration :
The Omega Co, is having four departments. A, B, and C are production departments and D is
a servicing department. The actual costs for a period are as follows.
Rs.
Rent
2,000
Repairs
1,200
Depreciation
900
Light
200
Supervision
3,000
Insurance
1,000
Employees Insurance (Employers liability)
300
Power
1,800
The following data are also available in respect of departments.

Dept. A
Dept. B
Dept. C
Dept. D
150
110
90
50
24
16
12
8,000
6,000
4,000
2,000
Value of plant (Rs.)
24,000
18,000
12,000
6,000
Value of stock (Rs.)
15,000
9,000
6,000
Area sq. ft.

Number of workers
Total wages (Rs.)
Apportion the cost to the various departments on the most equitable method.
292
Solution :
Apportionment of Overheads
Particulars
Base
Total
Rs.
Dept.
A
Rs.
Dept.
B
Rs.
Dept.
C
Rs.
Dept.
D
Rs.
Rent
Area sq. ft.
2,000
750
550
450
250
Repairs
Total wages
1,200
480
360
240
120
Depreciation
Value of Plant
900
360
270
180
90
Light
Area sq. ft.
200
75
55
45
25
Supervision
No. of workers
3,000
1,200
800
600
400
Insurance
Value of stock
1,000
500
300
200
Employees Insurance
(Employers Liabilities)
No. of workers
300
120
80
60
40
Power
Value of Plant
1,800
720
540
360
180
10,400
4,205
2,955
2,135
1,105
Notes :
It is assumed that the insurance is payable only on stock. Had it been assumed that it is
payable on stock as well as plant, the base would have been the combined value of stock and
plant.
For the apportionment of power cost, Kwh/HP rating would have been an ideal base. As
relevant data is not available, it is apportioned on the basis of value of plant.
Repairs are apportioned on the basis of total wages assuming that repair charges consist of
mainly labour charges.
(3)
Secondary Apportionment :
With the process of primary apportionment or distribution, the loading of overheads for all
the departments i.e. production as well as service departments can be obtained. Next
step is to transfer the overheads of non-production departments to production departments,
as the various cost centres move through the production departments only. This is in the
form of Secondary apportionment or distribution of overheads.
Overhead Cost
293
The usual bases which can be selected for the secondary apportionment may be as
below :
(1)
Maintenance Dept. - Number of hours worked.
(2)
Stores Dept. - Number of requisitions.
(3)
Purchase Dept. - Number of Purchase orders
(4)
Building Service Dept. - Area
(5)
Welfare/ Canteen and other facilities - Number of employees.
(6)
Personnel or Time keeping Dept. - Number of employees.
(7)
Internal Transport - Weight/value of goods moved.
While apportioning the overheads of non-production departments to production

departments, the problem will be there if non-production departments are rendering the
services inter-se.
There can be two ways to handle the situation like this (A) Ignore the services given by one service department to another. The defects involved with
this method are very obvious.
Illustration :
Following figures are extracted from the accounts of M/s. Vasant Works for the month of
July 1983.
Production Depts.
P1
P2
Service Depts.
S1
S2 S3
Indirect Material
280
140
170
350 160
Indirect Wages
324
312
296
190 218
Power and Light
Rs. 3,000
Supervision Charges
Rs. 2,200
Rent and Taxes
Rs.
500
Insurance on assets
Rs.
60
Depreciation at 12% p.a. on capital value of assets to be considered. From the above information
and the following departmental data, prepare overhead recovery rates for the production
departments PI and P2 on the basis of direct labour hours. The expenses of service departments
should be apportioned straight to the production depts. with the information that SI is tool
room, S2 is maintenance dept. and S3 is stores dept.
294
Departmental Data :
P1
P2
S1
S2
S3
400
200
100
200
100
Capital Value of Assets (Ps.)
8000
4000
7000
5000
6000
Kilowatt Hours
4000
3000
1000
1000
1000
150
100
75
100
125
Direct Labour Hours
5000
5000
Number of requisitions
1000
300
Area (sq. ft.)
Number of employees
Solution :
Statement showing apportionment of overheads
Items
Base
P1
Rs.
P2
Rs.
S1
Rs.
S2
Rs.
S3
Rs.
Indirect Material
Allocation
280
140
170
350
160
Indirect wages
Allocation
324
312
296
190
218
Power & Light
Kilowatt Hrs
1200
900
300
300
300
Supervision
No. of employees
600
400
300
400
500
Rent & Taxes
Area
200
100
50
100
50
Insurance on Assets
Value of assets
16
14
10
12
Depreciation
Value of assets
80
40
70
50
60
2700
1900
1200
1400
1300
(-)1200
Dept. S1
Labour Hours
600
600
Dept. S2
Labour Hours
700
700
Dept. S3
No. of requisitions
1000
300
5,000
3,500
(-)1400
(-)1300
(B) If it is decided to consider the services rendered by one service department to another,
the first problem will be to decide the percentage in which services are given by service
departments inter-se. After such percentage is decided, the secondary apportionment
can be made by either of the following methods.
(i)
Simultaneous Equation Method : Under this method the amount of overheads of

each production department can be obtained by solving simultaneous equations.
Overhead Cost
295
(ii)
Repeated Distribution Method : Under this method service dept. overheads are
distributed to other departments, production as well as service, on agreed percentage
and this process is repeated till the figures of service departments are exhausted or
are too small to consider further apportionment.
Illustration :
A company has 3 production depts. and 2 service depts. and for a period departmental
distribution summary has the following totals.
Production Depts.
A ..Rs. 800
B Rs. 700
Service Depts.
1 ....Rs. 234
2.. Rs. 300
C. Rs. 500
The expenses of service depts. are charged out on a percentage basis as :

A
Service Dept. 1
20%
40%
30%
10%
Service Dept. 2
40%
20%
20%
20%
You are required to show the apportionment of overheads.

Solution :
(a)
Simultaneous Equation Method :

Let x
total overheads of Dept. 1
total overheads of Dept. 2
234+ 2/10 y
and y
300 1/10 x
10 x
2340 + 2y
...(1)
3000 + x
...(2)
and 10 y =
Rearranging equation 2 and multiplying equation I by 5

10y
10y =
3000 + x
Adding 0 =
14700 49x
49 x
14700
300
However, Y =
296
11700 - 50x
...(3)
300 + 1/10 x
300 + 1/10 x 300
330
...(4)
Total overheads can be apportioned on the basis of agreed percentages to production

departments as below.
Total
Rs.
Dept. A
Rs.
Dept. B
Rs.
Dept. C
Rs.
2,000
800
700
500
Dept. 1 (90% of Rs. 300)
270
60
120
90
Dept. 2 (80% of Rs. 330)
264
132
66
66
2534
992
886
656
As per Primary appointment
(b)
Repeated Distribution Method :

Dept. A
Rs.
Dept. B
Rs.
Dept. C
Rs.
Dept. 1
Rs.
Dept. 2
Rs.
800
700
500
234
300
Dept. 1
47
94
70
(-) 234
23
Dept. 2
129
65
64
65
(-) 323
Dept. 1
13
26
20
(-) 65
Dept. 2
(-) 6
992
886
656
As per Primary appointment
(3)
Absorption :
The process of secondary apportionment of overheads, ensures the loading of overheads
to production departments. Now the next stage is that each job or product should get the
loading of the overheads while it is moving through the production department and this
process is in the form of Absorption or Recovery of overheads. There can be a number of
methods for absorbing the overheads but the ultimate selection of method has to be
made after considering various factors like type of industry, nature of products,
manufacturing process, requirements and policy of management, cost of operating the
system etc.
The various methods which can be considered for deciding the rates of overhead absorption
are as below :
(1)
Direct Materials Cost Percentage Rate :

This is calculated as :
Amount of overheads to be absorbed
Direct Materials cost
Overhead Cost
100
297
E.g. If production overheads to be absorbed are Rs. 25,000/and Direct materials cost is Rs. 50,000, the absorption rate will be :
25,000
50,000
X 100 i.e. 50%
Now if the direct materials cost of a job is Rs. 500, it will be getting the loading of
overheads to the extent of 50% of direct materials cost, i.e. Rs. 250. This method is
useful if materials cost forms a major part of production cost and is normally used if
materials costs are stable and equipments used remain unchanged.
This method leads to unsatisfactory results due to following reasons.
(2)
(i)
There can be some situations where material prices vary without any change in the
amount of over heads, in which case, this method may show wrong results.
(ii)
If this method is used, a job using expensive material may get high loading of
overheads as compared to a job using cheap material, which may not be fair.
Direct Wages Percentage Rate :

Direct wages cost
X 100
E.g. If the production overheads to be absorbed are Rs. 10,000 and direct wages cost is
Rs. 40,000, the absorption rate will be :
10,000
X 100 i.e. 25%
40,000
Now if the direct wages cost of a job is Rs. 400, it will be getting the loading of overheads
to the extent of 25% of direct wages cost, i.e. Rs. 100. This method is useful if labour
cost forms a major part of production cost and also if the work performed by all the
workers is uniform, ratio of skilled and unskilled workers is constant and labour rates do
not fluctuate widely.
The problem with this method is that there is very little relationship between direct wages
and overhead expenses. It may give wrong results if the workers vary in ability.
298
(3)
Prime Cost Percentage Rate :

X 100
Prime Cost
E.g. if the production overheads to be absorbed are Rs. 16,000 and prime cost is
Rs. 80,000, the absorption rate will be :
16,000
X 100 i.e. 20%
80,000
Now if the prime cost of a job is Rs. 250, it will be getting the loading of overheads to the
extent of 20% of prime cost, i.e. Rs. 50.
This method is useful in this sense that it considers both the materials cost as well as
labour cost.
(4)
Labour Hour Rate :

Labour hours required for production.
E.g. if production overheads to be absorbed are Rs. 50,000 and labour hours worked are
100,000, the absorption rate will be :
Rs. 50,000
i.e. Re. 0.50 per labour hour.
100,000
Now, if a job requires 20 labour hours to complete it, the loading of overheads to the
same will be Re. 0.50 per labour hour i.e. Rs. 10/-.
This method is useful if labour is the most important element of cost.
However, additional records are required to be kept for time booking per job. Further, if
machinery forms a dominant portion in production cost, this method may lead to wrong
results.
Overhead Cost
299
(5)
Machine Hour Rate :

Number of Machine Hours
E.g. if production overheads to be absorbed are Rs. 20,000 and machine hours worked
as 5000, the absorption rate will be
Rs, 20,000
i. e. Rs. 4 per machine hour.
5,000
Now if a job requires 25 machine hours to complete, the loading of overheads to the same will
be Rs. 4 per machine hour, i.e. Rs. 100.
If the machine use accounts for a large element of cost in the overall production cost, then this
method can be used conveniently. This rate can be considered to be useful and ideal especially
in the days of high mechanisation and automation.
While computing the machine hour rate, it is necessary to consider the various overheads
required to be incurred for running a machine or group of machines treating the same as
distinct cost centres.
Illustration :
Following information relates to activities of a production dept. of a factory for a certain period.
Direct Materials used
Rs. 4,000
Direct wages
Rs. 6,000
Direct Labour hours worked

(Including 20,000 hrs. of Machine operations)
Overheads chargeable to the dept.
24,000
Rs. 5,000
For order No. 156 carried out in dept. relevant figures were.
Direct Materials used
Rs. 200
Direct wages
Rs. 165
Direct labour hours

(Including 800 machine hours)
820
Calculate the overheads chargeable to Order No. 156 by 5 cost rates.
300
Solution :
Calculation of overhead absorption rate
(a)
Direct Material Cost percentage :

Amount of overheads
=
(b)
Rs. 5,000
Rs. 4,000
X 100
X 100 = 125%
Direct Labour Cost percentage :

Amount of overheads
X 100
Direct Labour Cost

Rs. 5,000
=
(c)
Rs. 6,000
X 100 = 83 1/3%
Prime Cost percentage :

Amount of overheads
X 100
Prime Cost
=
(d)
Rs. 5,000
Rs. 10,000
X 100 = 50%
Labour Hour Rate :

Amount of overheads
Direct Labour Hours
=
Rs. 5,000
= Re. 0. 2083 / Labour Hour.
24,000
(e)
Machine Hour Rate

Amount of overheads
Machine Hours
=
Rs. 5,000
= Rs 0.25 / Machine Hour.
20,000
Overhead Cost
301
The overheads chargeable to Order No. 156 and the total cost of the same can be calculated
as below :
Material
Rs.
Labour
Rs.
Overheads
Rs.
Total
Rs.
200.00
165.00
250.00
615.00
Cost percentage
200.00
165.00
137.50
502.50
(c)
Prime Cost percentage
200.00
165.00
182.50
547.50
(d)
Labour Hour Rate
200.00
165.00
170.83
535.83
(e)
Machine Hour Rate
200.00
165.00
200.00
565.00
(a)
Direct Material
Cost percentage
(b)
Direct Labour
Illustration :
Compute the machine hour rate from the following data.
Cost of the machine
Rs. 1,00,000
Installation charges
Rs.
10,000
Estimated scrap value after the expiry of life (15 years)
Rs.
5,000
Rent and Rates for the shop per month
Rs.
200
General lighting for the shop per month
Rs.
300
Insurance charges for the machine per annum
Rs.
960
Repairs and Maintenance expenses per month
Rs.
1,000
Rate of power per 100 Units
Rs.
20
Shop supervisors salary per month
Rs.
600
Power consumption 10 Units per hour.

Estimated working hours per annum 2,200
(This includes setting up time of 200 hours)
The machine occupies 1/4 of the total area of the shop. The supervisor is expected to devote
1/5 of the total time for the supervision of the machine.
302
Calculation of Machine Hour Rate :

(a)
Standing Charges
Rs.
Depreciation
7,000.00
Rent and Rates
600.00
General lighting
900.00
Insurance Charges
960.00
12,000.00
Shop Supervisors salary
1,440.00
Annual standing charges
22,900.00
Annual Machine Hours (Excluding setting up time)

Hourly standing charges
(b)
2000
Rs. 11.45
Running charges :
Power Expenses
Rate of power 20 paise per unit.
Power consumption - 10 units per hour.
Hourly power expenses
(c)
Rs. 2.00
Machine Hour Rate i.e. a + b
Rs. 13.45
Working Notes :
(1)
It is assumed that during the setting up time, the machine will not be used for the
intended purpose and hence the said time is ignored for the calculation of machine hour
rate.
(2)
It is assumed that the depreciation is charged on straight-line basis.

Hence, it is calculated as :
Cost of Machine + Installation charges Estimated scrap value
Estimated life of machine
=
(3)
Rs. 100,000 + Rs. 10,000 Rs 5000

15 years
= Rs. 7,000 p.a.
It is assumed that the Repairs and Maintenance expenses are incurred only for the
machine.
Overhead Cost
303
Actual V/s. Predetermined Overhead Absorption Rates

The overhead absorption rates can be considered on actual basis or predetermined basis. For
computing the absorption rates on actual basis, the actual data for the previous period is
considered, i. e. Actual overheads, actual direct materials/wages cost, actual prime cost,
actual labour hours worked, actual machine hours worked etc. However, the actual overhead
absorption rates have certain limitations.
(1)
The actual details are available only after the end of actual accounting period and required
details may not be available either for proper control of overheads or for price fixation.
(2)
If the production is of seasonal nature, overhead absorption rates will not be constant
monthwise and comparison of production costs monthwise will be difficult.
As such, it is customary to consider predetermined overheads absorption rates instead of

actual overhead absorption rates. By predetermined rates it is meant that instead of considering
actual data in respect of Direct Materials/Wages/Prime Cost or Labour/Machine Hours,
estimations are made in respect of the same and predetermined overhead absorption rate is
applied whenever computations are to be made in respect of product cost of a job.
Under Absorption or Over Absorption of Overheads
If the organization follows the policy of considering predetermined overhead absorption rates,
it may face the problem of under or over absorption of overheads if the actual overheads to be
absorbed or the bases for the absorption, i.e. Materials/ Wages/ Prime cost or Labour/Machine
Hours etc. vary from the assumption. E.g. A Company considers the overhead absorption rate
as a direct materials cost percentage rate. It is decided that predetermined overhead absorption
rate should be considered for the forthcoming year 1989. As such, the predetermined overhead
rate was estimated on the basis of following details.
i.e.
Estimated amount of overheads

Estimated Direct Materials cost
i.e. Rs. 10,000

Rs. 50,000
X 100
X 100 i.e. 20%
Now, on this basis all the jobs moving through that department during 1989 will be getting the
loading of overheads @ 20% of Direct Materials Costs.
After the year 1989 ended, the actual details are computed and it is found out that whereas
Direct Materials cost was as estimated, i.e. Rs. 50,000, the actual amount of overheads was
reduced to Rs. 9,000. As such, the rate at which the overheads should have been absorbed,
should have been
304
Rs. 9,000
X 100, i.e. 18% and not 20%
as originally considered
Rs. 50,000
Such situation gives rise to the under absorption or over absorption of overheads.
The situation of under absorption arises if the overheads absorbed are less than the actual
overheads. The situation of over absorption arises if the overheads absorbed are more than the
actual overheads.
E.g.
Period
Overheads
Absorbed
Rs.
Actual
Overheads
Rs.
Remarks
7,500
9,000
Underabsorption
II
10,000
8,000
Overabsorption.
Causes :
Under absorption of overheads may take place due to the reasons like.
Actual overheads being more than the estimated overheads or
Actual output or hours worked being less than those as estimated.
Over absorption of overheads may take place due to the reasons like
Actual overheads being less than the estimated overheads OR
Actual output or hours worked being more than those as estimated.
Treatment of Under or Over Absorbed Overheads :

The overheads which are under or over absorbed may be treated in either of the following
ways
(1)
Use of supplementary rate : If the amount of under or over absorbed overheads is

considerably significant, the cost of the cost centres may be adjusted by means of the
use of supplementary overhead absorption rate. This method of treating the over or under
absorption of overheads is most important where the cost is considered as a base for
quoting selling prices, E.g. Cost plus contracts.
E.g. The predetermined overhead absorption rate, for the forthcoming period of months,
was decided as below.
Amount of overheads
Total labour Hours
Overhead Cost
Rs. 50,000
Rs. 2 / Labour Hour.
25,000
305
A mid term review of 6 monthly operations revealed that whereas the total labour hours
during the period were 12,500, the amount of overheads incurred was Rs. 30,000. The
overheads actually absorbed will be 12,500 hours x Rs. 2 i.e. Rs. 25,000. Considering
the same trend of amount of overheads, the total annual overheads are likely to be
Rs. 60,000, out of which Rs. 25,000 are already absorbed. As such, for the remaining 6
months, the overhead absorption rate may be calculated as :
Revised amount of overheads
Number of Labour Hours
=
=
Rs. 60,000 Rs. 25,000

12,500
Rs. 35,000
= Rs. 2.80 / Labour Hour.
12,500
(2)
Carrying over to remaining period : In case of seasonal types of organization, the

overheads under or over absorbed during a certain period may be carried over to the
remaining part of the accounting period with the hope that they may be compensated
during the remaining period of time.
(3)
Writing off to Costing Profit and Loss Account : In case of the under or over absorption
of the overheads arising out of the abnormal circumstances, they are written off to Costing
Profit and Loss Account.
Illustration :
The budgeted working conditions of a cost centre are as follows :
Normal working per week
42 hours
No. of machines
14
Normal weekly loss of hours on maintenance etc.
5 hours per machine
No. of weeks worked per year
48
Estimated annual overheads
Rs. 1,24,320
Estimated direct wage rate
Rs. 4 per hour.
Wages incurred
Rs. 9,000
Overheads incurred
Rs. 10,200
Machine hours produced
2,000
Actual result in respect of a 4 week period are :
306
You are required to calculate :

(a)
The overhead rate per machine hour
(b)
The amount of under or overabsorption of wages and overheads.
Solution :
(a)
Normal working hours per year

(For all 14 machines)
42 weekly hours per machine

x 14 machines x 48 weeks
= 28,224 machine hours.
(b)
Hours lost on maintenance
(c)
Effective machine hours i.e., a - b
5 hours per week x 14 machines

x 48 weeks = 3,360 machine
hours.
24,864 machine hours.
(d)
Estimated annual overheads
Rs. 1,24,320
(e)
Machine hour rate i.e., d / c
Rs. 5
(f)
Overheads absorbed
2000 machine hours x Rs. 5

= Rs. 10,000
(g)
Overheads actually incurred
(h)
Overheads underabsorbed
i.e., g - f
Rs. 10,200
Rs. 200
WAGES
(a)
Labour hours for 4 weeks
42 hours x 4 week = 168 hours
(b)
For 14 machines
168 hours x 14 machines

= 2,352 hours
(c)
Estimated direct wage rate
Rs. 4 per hour
(d)
Estimated direct wages for4 weeks i.e., b x c
Rs. 9,408
(e)
Wages actually incurred
Rs. 9,000
(f)
Wages overabsorbed
i.e., d-e
Rs. 408
Control Over Overheads :

As the basic intention of cost accounting is to exercise the control over the costs and as the
overheads is a part of cost, cost accounting procedures attempt to control the overheads also.
For this purpose, the following propositions should be remembered :
(1)
The success of procedures to control the overheads largely depends upon the correct
classification of the overheads. This classification can be done from the various angles.
Overhead Cost
307
(a)
Functionwise : This takes the form of classification in the form of factory overheads,
administration overheads and selling and distribution overheads.
(b)
Variabilitywise : This takes the form of classification in the form of fixed overheads,
variable overheads and semi-fixed or semi variable overheads.
(c)
Normalitywise : This takes the form of classification in the form of normal overheads
and abnormal overheads.
Fixed overheads normally arise as a result of policy and are largely uncontrollable at the lower
level of management. They can be controlled at the top level of management. However, the
variable overheads can be controlled at the lower or middle level of management as well.
Most of the administration overheads are fixed in nature and can be controlled mainly at top
management level. However, the factory overheads can be controlled at lower or middle
management level also.
(2)
After the correct classification of overheads, use may be made of following two techniques
with the intention to exercise proper control over overheads.
(a)
Budgetary control
(b)
Standard costing
Both these techniques are discussed in details in the following chapters.

However, both these techniques necessarily involve the following stages in the process
of implementation.
(i)
Planning : This lays down the course of action to be taken in future.

In case of budgetary control, it is in the form of the budgets and in case of standard
costing, it is in the form of the standard cost.
(ii)
Implementation of plan : This indicates actual steps to execute the plan. For this,
downward communication may be necessary from top management level to lower
management level.
(iii) Measuring actual performance, comparison with plans and computing

variances : Measurement of actual performance may be in terms of actual costs or
actual output. Actual costs and actual output is compared with the planned performance
and variations, if any are calculated.
(iv) Analysis of variances and decision making : Variations between actual performance
and planned performance is required to be analysed as to the causes and proper corrective
actions are required to be taken to remove unfavourable variations or maintain favourable
variations.
308
(3)
Classification of overheads as fixed and variable, facilitates the preparation of flexible

budgets which provides proper base for comparison in the form of budgeted overheads
for any level of activity actually attained. Flexible budgets may be treated as an improved
method to control the overheads.
(1)
Meera Industries Limited is a single product organization having a manufacturing capacity

of 6,000 units per week of 48 hours. The output data vis-a-vis different elements of cost
for three consecutive weeks are given below :
Units
Produced
Direct
Material
Rs.
Direct
Labour
Rs.
Total factory overheads

(Variable and Fixed)
Rs.
2,400
4,800
6,000
37,200
2,800
5,600
7,000
38,400
3,600
7,200
9,000
40,800
As a cost Accountant, you are asked by the company to work out the selling price assuming
level of 4,000 units per week and a profit of 20% on selling price.
Solution :
It can be observed that an increase in production by 400 units increases the total factory
overheads by Rs. 1,200 indicating that per unit variable overheads are Rs. 3. Hence, at the
activity level of 2,400 units, the total variable overheads are Rs. 7,200 i.e. 2400 units x Rs.3
per unit, out of total overheads of Rs. 37,200. Hence, the balance amount represents fixed
overheads. It should be noted that the direct material cost and direct labour cost represents
the variable cost of production. At 2,400 units, per unit cost is as below :
Direct material - Rs. 4800 / 2400 units = Rs. 2 / per unit.
Direct Labour - Rs. 6000 / 2400 units = Rs. 2.5 per unit
The cost sheet for the production of 4000 units can be worked out as below :
Overhead Cost
309
Cost Sheet - 4000 units

Per Unit
Rs.
Total
Rs.
2.00
8,000
Direct Labour Cost
2.50
10,000
Variable Overheads
3.00
12,000
Fixed Overheads
7.50
30,000
15.00
60,000
3.75
15,000
18.75
75,000
Total Cost
Add : Profit i.e. 20% of selling price of
Or 25% of total cost
Sales
(2)
XYZ Ltd., a manufacturing company, having an extensive marketing net work throughout
the country, sells its products through four zonal sales offices viz. A,B,C and D. The
budgeted expenditure for the year are given below :
Rs.
Sales Managers salary
1,20,000
Expenses relating to Sales Managers office
80,000
Travelling salesmens salaries
3,20,000
Travelling Expenses
36,000
Advertisement
30,000
Godown Rent-Zone
15,000
25,200
9,800
18,000
68,000
Insurance on inventories
Commission on sales @ 5% on sales
310
20,000
6,00,000
The following further particulars are also available :

A
36
48
16
20
Total mileage covered
6000
14000
4500
5500
Allocation of Advertisement
30%
30%
20%
20%
Sales (Rs. in lakhs)

No. of salesmen
Average stock (Rs. in lakhs)
Based on the above details, compute zonewise selling overheads, as a percentage to sales.
Solution :
Calculation of Sales Overheads - Zone wise
Items
Base
Total
Rs.
Rs.
Rs.
Rs.
Rs.
1. Sales
Managers Salary
2. Expenses of Sales
Managers office
Sales
1,20,000
36,000
48,000
16,000
20,000
Sales
80,000
24,000
32,000
10,667
13,333
3. Travelling salesmens
Salaries
No. of Salesman
3,20,000
1,00,000
1,20,000
40,000
60,000
4. Travelling Expenses
Mileage covered
36,000
7,200
16,800
5,400
6,600
5. Advertisement
6. Godown Rent
Allocation
Allocation
30,000
68,000
9,000
15,000
9,000
25,200
6,000
9,800
6,000
18,000
7. Insurance on
inventories
8. Sales Commission
Average stock
20,000
6,000
8,000
4,000
2,000
6,00,000
1,80,000
2,40,000
80,000
1,00,000
12,74,000
3,77,200
4,99,000 1,71,867
2,25,933
120
36
48
16
20
10.62%
10.48%
10.40%
10.74%
11.30%
Sales
Total
Overheads
Sales in Lakhs Rs.
Overheads as % of sales
(3)
The following yearly charges are incurred in respect of a machine where work is done by
means of 5 machines of exactly same type.
(1)
Rent and Rates
Rs.
4,800
(2)
Depreciation on each machine
Rs.
500
(3)
Repairs & maintenance of 5 machines
Rs.
1,000
(4)
Power consumed (as per meter at 5 paise per unit)
Rs.
3,000
(5)
Electric charges for the shop
Rs.
450
Overhead Cost
311
(6)
Two attendants looking after 5 machines and are

paid Rs. 700 per year each
Rs.
1,400
(7)
Supervision One supervisor looking after 5 machines and paid
Rs.
3,000
(8)
Sundry supplies for the shop
Rs.
450
The machine uses 10 units of power per hour. Calculate the machine hour rate.
Solution :
Calculation of Machine Hour Rate
Rs.
(a)
Standing charges :
Rent and Rates
960
Depreciation
500
200
Electricity charges
90
Attendants salary
280
Supervisors Salary
600
Sundry Supplies
90
Annual standing charges
2,720
Annual Machine Working Hours
1,200
Hourly Standing Charges

(b)
Rs. 2.27
Running charges :
Power charges - Rate of power - 5 paise per unit
Power consumption - 10 units per hour
(c)
Hourly power expenses
Rs. 0.50
Machine Hour Rate i.e. a + b
Rs. 2.77
Working Notes :
Number of machine working hours are calculated as below :
312
(a)
Total power cost for the shop
- Rs.
3.000
(b)
Power cost relating to the machine
- Rs.
600
(c)
Rate of power - 5 paise per unit
(4)
(d)
Total power consumption in units Rs. 600

= 12.000 units
Paise 5
(e)
Rate of power consumption
(f)
If total units consumed are 12.000 and if rate of power consumption is 10 units per
hour, it means that the machine must have worked for 1,200 hours.
- 10 units per hour
From the following data, work out the predetermined machine hour rates for departments
A and B of a factory.
Preliminary Estimates of Expenses
Total
Rs.
Dept. A
Rs.
Dept. B
Rs.
15,000
Spare Parts
8,000
3,000
5,000
Consumable Stores
5,000
2,000
3,000
30,000
10,000
20,000
3,000
40,000
7,000
Power
Depreciation on Machinery
Insurance on Machinery
Indirect Labour
Building Maintenance
The final estimates are to be prepared on the basis of above figures after taking into consideration
the following factors :
(1)
An increase of 10% in the price of spare parts.
(2)
An increase of 20% in the consumption of spare parts for Department B only.
(3)
Increase in the straightline method of depreciation from 10% on the original value of
machinery to 12%.
(4)
15% general increase in wage rates.
The following information is available

Dept. A
Dept. B
80,000
1,20,000
Estimated Machine Hours
25,000
30,000
Floor Space (sq. ft.)
15,000
20,000
Estimated Direct Labour Hours

Ratio of K W Rating
Overhead Cost
313
Solution :
Calculation of machine hour rate
Expenses
Base
Power
KW Rating
Spare Parts
Total
Rs.
Dept. A Dept. B
Rs.
Rs.
15,000
9,000
6,000
Allocation and adjustment for

Final Estimates
9,900
3,300
6,600
Consumable stores
Allocation
5,000
2,000
3,000
Allocation and adjustments for

36,000
12,000
24,000
3,000
1,000
2,000
46,000
18,400
27,600
7,000
3,000
4,000
1,21,900
48,700
73,200
25,000
30,000
1.948
2.44
Final Estimates
Insurance on Machinery
Ratio of depreciation
Indirect Labour
Direct Labour Hours and

adjustment for Final Estimates
Building Maintenance
Floor space
Estimated Machine Hours

Machine Hour Rate
Rs.
Working Notes :
(1)
Spare Part Cost
Total
Dept A
Dept B
Original Estimate
8,000
3,000
5,000
+ Extra consumption
1,000
1,000
9,000
3,000
6,000
900
300
600
9,900
3,300
6,600
+ 10% Price Increase
(5)
The factory overhead costs of four production departments of a company engaged in

executing job orders, for an accounting year, are as follows :
Depts.
314
Rs.
19,300
4,200
4,000
2,000
Overhead has been applied as under

Dept A - Rs. 1.50 per machine hour for 14,000 hours
Dept B - Rs. 1.30 per Direct Labour Hour for 3,000 hours
Dept C - 80% of Direct Labour cost of Rs. 6,000
Dept D - Rs. 2 per piece for 950 pieces.
Find out the amount of departmentwise under or over absorbed factory overheads.
Solution :
(a)
(b)
Factory Overheads absorbed

Dept.
Rs.
Base
21,000
Rs. 1.50 per Machine Hour for 14,000 hours
3,900
Rs. 1.30 per Direct Labour Hour for 3,000 hours
4,800
80% of Direct Labour cost of Rs. 6,000
1,900
Rs. 2 per piece for 950 pieces
Calculation of under or over absorption

Dept.
Overheads
Incurred
Rs.
Overheads
Absorbed
Rs.
Over
Absorption
Rs.
Under
Absorption
Rs.
19,300
21,000
1,700
4,200
3,900
300
4,000
4,800
800
2,000
1,900
100
29,500
31,600
2,500
400
Net Over absorption

(6)
Rs. 2,100
In a factory, annual average charges for direct wages amount to Rs. 4,80,000. Following
are some of the expenses incurred in factory.
a.
Works Managers salary Rs. 50,000
b.
Factory Rent Rs. 36,000. The total area is 45,000 Sq. Ft. out of which shop is in
40,000 Sq. Ft.
c.
Wages of Peons and Sweepers Rs. 7,000
d.
Other factory overheads Rs. 53,000
Overhead Cost
315
A work order is executed in a shops part occupying an area of 6,000 Sq. Ft. and costs
Rs. 10,000 in wages. If the total wages for all work orders executed in the shop amount to
Rs. 1,60,000, calculate the total amount of factory overheads charges to be allocated to this
work order.
Solution :
Factory Rent Rs. 36,000
40,000 Sq. ft.
Rent of shop Rs. 32,000 i.e., Rs. 36,000 X
45,000 Sq. ft.
Rent for that area of shop where work order is executed. i.e.
Rs. 32,000 X
6,000 Sq. ft.

40,000 Sq. ft.
= Rs. 4,800
Apportionment of rent to work order on the basis of wages Rs. 10,000

Rs. 160,000
X Rs. 4,800 = Rs. 300
Other factory overheads

Rs.
Works Managers Salary
50,000
Factory Rent (Balance)
4,000
Wages of Peons /Sweepers
7,000
Others
53,000
1,14,000
Apportionment of overheads to works order on the basis of wages

Rs. 10,000
Rs. 4,80,000
X Rs. 1,14,000 = Rs. 2,375
Factory overheads chargeable to the work order
316
Rent
Rs.
300
Factory overheads
Rs.
2,375
Rs.
2.675
(7)
Superclass Co. Ltd. has three production departments X, Y and Z and two service
Departments A and B.
The following estimated figures for a certain period have been made available.
Rs.
Rent and Rates
10,000
Lighting and Electricity
1,200
Indirect wages
3,000
Power
3,000
Depreciation of machinery
20,000
Other expenses and sundries
20,000
The following further details are also available.

Total
10,000
2,000
2,500
3,000
2,000
500
Light Points (Nos.)
120
20
30
40
20
10
Direct wages (Rs.)
20,000
6,000
4,000
6,000
3,000
1,000
Horsepower of machines
300
120
60
100
20
Cost of Machinery (Rs.)
1,00,000
24,000
32,000
40,000
2,000
2,000
4,670
3,020
3,050
Floor space (Sq. Mts.)
Working Hours
The expenses of the service departments are to be allocated as follows.

X
20%
30%
40%
10%
40%
20%
30%
10%
You are required to calculate the overhead absorption rate per hour in respect of the three
production departments.
What will the total cost of an article with material cost of Rs. 50 and direct labour cost of
Rs. 40 which passes through X, Y and Z for 2, 3 and 4 hours respectively.
Overhead Cost
317
Solution :
Primary Apportionment of Overheads
Expenses
Base
X
Rs.
Y
Rs.
Z
Rs.
A
Rs.
B
Rs.
Rent & Rates
Floor space
2000
2500
3000
2000
500
Lighting & Electricity
Light points
200
300
400
200
100
Indirect wages
Direct wages
900
600
900
450
150
Power
HP of machines
1200
600
1000
200
Depreciation
Cost of machines
4800
6400
8000
400
400
Other expenses
Direct wages
6000
4000
6000
3000
1000
Direct wages
(Only Service Depts.)
Allocation
3000
1000
15100
14400
19300
9250
3150
Secondary Apportionment of Overheads

Result of Primary Apportionment
X - Rs. 15,100
Y - Rs. 14,400
A - Rs. 9,250
B - Rs. 3,150
Let X =
Total overheads of Dept. A
Y =
Total overheads of Dept. B
X =
9,250 + Y/10
Y =
3,150 + X/10
Z - Rs. 19,300
10 X =
92,500 + Y
...(1)
10
31,500 + X
...(2)
Y =
Multiplying equation 1 by 10 and rearranging :
318
-10 Y =
9,25,000 - 100 X
10 Y
31,500 + X
Adding, 0
9,56,500 - 99X
99X
9,56,500
9,662
...(3)
4,116
...(4)
Total overheads can be apportioned to production departments at agreed percentages to

calculate the overhead absorption rate as below :
Total
Rs.
X
Rs.
Y
Rs.
Z
Rs.
48,800
15,100
14,400
19,300
Dept A 90% of Rs. 9662
8,696
1,933
2,898
3,865
Dept B 90% of Rs. 4116
3,704
1,647
822
1,235
61,200
18,680
18,120
24,400
4,670
3,020
3,050
4.00
6.00
8.00
As per Primary apportionment
Working Hours
Labour Hour Rate Rs.
Calculation of Total Cost

Rs.
80
Direct Labour Cost
40
Overheads
Dept X - 2 Hrs x Rs. 4/ Hour
Rs.
Dept Y - 3 Hrs x Rs. 6/ Hour
Rs.
18
Dept 2 - 4 Hrs x Rs. 8/ Hour
Rs.
32
58
178
(8)
The expenses of a machine cost centre for a particular month are as under.
(i)
Power
Rs.
50,000
(ii)
Maintenance and Repairs
Rs.
10,000
(iii) Machine operators wages
Rs.
2,000
(iv)
Supervision
Rs.
6,000
(v)
Depreciation
Rs.
40,000
Overhead Cost
319
Other particulars are given below :

Products
Rate of Production
Production Units
30 Units per hour
1,800
10 Units per hour
500
6 Units per hour
300
4 Units per hour
260
The entire production was to be offered to Government on Cost Plus 20% basis. Material
Costs per unit are A - Rs. 40, B - Rs. 60, C - Rs. 100 and D - Rs. 300
Prepare a statement showing product wise cost and offer price.
Solution :
Total Cost of Machine Centre
Rs.
Power
50,000
Maintenance and Repairs
10,000
Machine operators wages
2,000
Supervision
6,000
Depreciation
40,000
1,08,000
On the basis of rate of production and number of units produced of each product, number of
machine hours used can be calculated as below :
Product
Rate of Production
Production
(Units)
Machine Hours
used
30 Units per hour
1,800
60
10 Units per hour
500
50
6 Units per hour
300
50
4 Units per hour
260
65
225
Machines Hour Rate
320
Rs. 1,08,000
225 Machine Hour
= Rs. 480 Machine Hour
Calculation of per unit total cost and offer price

Product Material
Cost
Machine Cost
Machine
Machine
Hours
Hour
Rate
Total
Machine
Cost
Total
Cost
Profit
20% of
Total
Cost
Offer
Price
2
Rs.
3
Rs.
4
Rs.
5
Rs.
6(2+5)
Rs.
7
Rs.
8
Rs.
40.00
1/30
480
16.00
56.00
11.20
67.20
60.00
1/10
480
48.00
108.00
21.60
129.60
100.00
1/6
480
80.00
180.00
36.00
216.00
300.00
480
120.00
420.00
84.00
504.00
Overhead Cost
321
QUESTIONS
1.
Discuss the factors which would create unabsorbed factory overheads and overabsorbed
factory overheads.
2.
Mention the broad principles on which overhead expenses are generally apportioned.
Upon what basis would you apportion the following expenses to individual cost centres
in an engineering unit?
Rent
(b)
Power
(c)
(d)
Lighting
3.
Explain the term underabsorption and overabsorption of overheads. Explain any three
methods of absorbing production overheads into the cost of production.
4.
Distinguish between actual and predetermined rates for absorption of factory overheads.
Cite the major problems involved in using actual rates and discuss how predetermined
rates eliminate this problem.
5.
How do you deal with under or over absorption of overheads? Mention the various items
that go into
6.
7.
322
(a)
(a)
Manufacturing overheads.
(b)
Administration overheads.
(c)
Selling overheads.
(d)
Distribution overheads.
What basis would you recommend for the apportionment of the following items of expenses
to production departments, giving justification for the suggested one.
(a)
Internal Transport.
(b)
Air-Conditioning.
(c)
General Factory Maintenance.
(d)
Stores.
(e)
Rent.
(f)
Labour office.
What is meant by apportionment of overheads? What can be considered as a good base

for apportioning the following overheads with reference to a Diesel Engine Manufacturing
Company?
(i)
Internal Transport
(ii)
Time Keeping expenses
(iii) Shop supervision

(iv)
Power, lighting and other utilities
Short Notes :
(a)
Machine Hour Rate
(b)
Control of overheads
(c)
Underabsorption and overabsorption of overheads
(d)
Treatment of overabsorption of overheads
(e)
Primary and Secondary apportionment of overheads
PROBLEMS
(1)
A certain type of factory produces a uniform type of article and has a capacity to produce
1,500 units per week of 48 hours. Following data shows different elements of costs for 3
weeks of 48 hours each when output has changed from one week to another.
Units Produced
Direct Material
Direct Labour
Rs.
Rs.
Factory Overheads
(Fixed & Variable)
Rs.
400
800
1,600
3,800
500
1,000
2,000
4,000
800
1,600
3,200
4,600
You are asked to find out selling price per unit when weekly output is 1,000 units and a profit
of 8.33% on selling price will be made.
(2)
A factory is having three production departments A, B and C and two service departmentsBoiler House and Pump Room. The Boiler House has to depend upon the Pump Room
for the supply of water and the Pump room in its turn is dependent on the boiler house for
supply of steam power for driving the pump. The expenses incurred by the production
departments during a period are A Rs. 8,00,000, B Rs. 7,00,000 and C - Rs. 5,00,000.
The expenses for boiler house is Rs. 2,34,000 and the pump room is Rs. 3,00,000.
The expenses of the boiler house and pump room are apportioned to the production
departments on the following basis.
Overhead Cost
323
BH
PR
Expenses of BH
20%
40%
30%
10%
Expenses of PR
40%
20%
20%
20%
Show clearly as to how the expenses of boiler house and pump room would be apportioned to
A, B and C departments. Use an Algebrical equation.
(3)
The overheads distribution summary for the month of September 1980 disclosed following
overheads expenses for departments mentioned below :
Production Depts.
Overheads
Service Depts.
Rs. 7,810
Rs. 12,543
Rs. 4,547
Rs. 4,000
Rs. 2,600
Expenses of service departments D and E are apportioned as follows.

A
30%
40%
20%
10%
10%
20%
50%
20%
You are required to find out the total cost of each production dept. by charging the respective
costs of service depts. by simultaneous equations method.
(4)
The primary distribution of expenses disclosed the following details in respect of production
departments PI, P2 and P3 and Service Departments S1 and S2
Dept.
Overheads (Rs.)
P1
P2
P3
S1
S2
6.300
7,400
2,800
4,500
2,000
The services given by S1 and S2 are as follows.

Dept.
P1
P2
P3
S1
S2
S1
40%
30%
20%
10%
S2
30%
30%
20%
20%
Find out the overheads to production Departments by using simultaneous equations method.
(5)
324
A company has three production cost centres A, B and C and two service cost centres
X and Y. Costs allocated to service cost centres are required to be apportioned to the
production centres to find out cost of production of different products. It is found that
benefit of service cost centres is also received by each other along with the production
cost centres. Overhead costs as allocated to the five cost centres and estimates of
benefits of service cost centres received by each of them are as under Cost Centres
Overhead Costs
as allocated
Rs.
A
B
C
X
Y
Estimates of benefits
received from service
centres %
80,000
40,000
20,000
20,000
10,000
20
30
40
10
20
25
50
5
-
Required Work out final overhead costs of each of the production departments including apportioned
cost of service centres using a.
Continuous Distribution Method
b.
Simultaneous Equations Method
(6)
The following particulars related to the production department of a factory for the month
of June 1985.
Rs.
Material Used
80,000
Direct Wages
72,000
Direct Labour Hours Worked
20,000
Hours of Machine operation
25,000
Overhead charges allocated to the department
90,000
Cost data of a particular work order carried out in the above department during June 1985 are
given below.
Rs.
Material Used
8,000
Direct wages
6,250
Labour hours booked
3,300
Machine hours booked
2,400
Overhead Cost
325
What would be the factory cost of the work order under the following methods of charging
overheads?
(i)
Direct Labour Cost Rate
(ii)
Machine Hour Rate
(iii) Direct Labour Hour Rate

(7)
The following information is extracted from the budget of A Ltd. for 1985.
Factory Overheads
..
Rs.
62,000
Direct Labour cost
..
Rs.
1,00,000
Direct Labour hours
..
1,55,000
Machine hours
..
50,000
The following details are available for job 195

Rs. 45
Direct Labour Cost
Rs. 50
Direct Labour hours
40
Machine hours
30
You are required to work out the overhead application rates and ascertain the cost of job 195
by using the following methods of overheads absorption.
(1) Direct Labour Hours Rate, (2) Direct Labour Cost, (3) Machine Hour Rate
(8)
Atlas Engineering Ltd. accepts a variety of jobs which require both manual and machine
operations. The budgeted Profit and Loss Account for the period 1996-97 is as follows :
(Rs. in Lakhs)
Sales
75
Cost :
Direct Materials
Direct Labour
10
5
Prime Cost
15
Production Overhead
30
Production Cost
45
Other Overheads
15
60
Profit
326
15
Other budgeted data Labour Hours for the period
2,500
Machine Hours for the period
1,500
No. of jobs for the period
300
An enquiry has been received recently from a customer and the production department has
prepared the following estimate of the prime cost required for the job Direct Material
2,500
Direct Labour
2,000
Prime Cost
4,500
Labour Hours required
= 80
Machine Hours required
= 50
You are required to a.
Calculate by different methods, six overhead absorption rates for absorption of production
overhead and comment on the suitability of each.
b.
Calculate the production overhead cost of the order based on each of the above rates.
c.
Give your recommendation to the company.
(9)
A company has two production departments and two service departments. The data
relating to a period are as under :
Production Depts.
PD1
PD2
Service Depts.
SD1
SD2
Direct Materials (Rs.)
80000
40000
10000
20000
Direct Wages (Rs.)
95000
50000
20000
10000
Overheads (Rs.)
80000
50000
30000
20000
20000
35000
12500
17500
13000
23000
10250
10000
Power requirement
at normal capacity
operation (kwh)
Actual power consumption
during the period (Kwh)
The power requirement of these departments are met by a power generation plant. The said
plant incurred an expenditure, which is not included above, of Rs. 1,21,875 out of which a sum
of Rs. 84,375 is variable and the rest fixed.
Overhead Cost
327
After apportionment of power generation plant costs to four departments, the service department
overheads are to be redistributed on the following bases :
PD1
PD2
SD1
SD2
SD1
50%
40%
10%
SD2
60%
20%
20%
You are required to :

a.
Apportion the power generation plant costs to the four departments.
b.
Re-apportion service department cost to the production departments.
c.
Calculate the overhead rates per direct labour hour of production departments, given that
the direct wages rates of PD1 and PD2 are Rs.- 5 and Rs. 4 respectively.
(10) Following information is extracted from the cost records of Hilton Ltd. which specialises
in the manufacture of automobile spares. The parts are manufactured in Department A
and assembled in Department B.
Total
Dept. A
Dept. B
Direct Labour hours worked
80,000
30,000
50,000
Machine Hours worked
30,000
25,000
5,000
400
353
47
Book Value of Machines (Rs.)
50,000
40,000
10,000
Floor Space (Sq.Ft.)
20,000
10,000
10,000
Direct Material
65,000
50,000
15,000
Direct Labour
90,000
40,000
50,000
Factory Rent
15,000
Supervision
6,000
2,500
3,500
Depreciation on Machines
5,000
Power
4,000
Repairs to Machines
2,000
1,600
400
Indirect Labour
4,000
2,000
2,000
Total
Dept. A
Dept. B
Materials
3,200
2,700
500
Labour
7,500
3,000
4,500
Machine Horse Power
The prime cost of batch B-401 has been booked as under
328
Direct Labour hours worked on Batch B-401 were 2,500 in Department A and 5,000 in
Department B. Machine hours worked on this batch were 1,250 in Department A and 600 in
Department B. Allocate overhead expenditure and calculate the cost of each unit in Batch B401 which consists of 1,000 units.
(11) Strongman Ltd. has three production departments A,B and C and two service departments
X and Y. The data available for the month of March 1991 concerning the organization
Rs.
Rent
15,000
Municipal Taxes
5,000
Electricity
2,400
Indirect wages
6,000
Power
6,000
40,000
Canteen Expenses
30,000
Other Labour related costs
10,000
Following particulars are also available Total
5,000
1,000
1,250
1500
1,000
250
Light Points (Nos.)
240
40
60
80
40
20
Direct Wages (Rs.)
40,000
12,000
8,000
12,000
6,000
2,000
150
60
30
50
10
20,0000
48,000
64,000
80,000
4,000
4,000
2,335
1,510
1,525
Floor Space (Sq. Mts.)
HP of Machines
Cost of Machines (Rs.)
Working Hours
The expenses of Service Departments are to be allocated in following manner A
20%
30%
40%
10%
40%
20%
30%
10%
You are requested to calculate the overhead absorption rate per hour in respect of the three
production departments.
Overhead Cost
329
(12) A company has 3 production departments A, B and C and two service departments X
and Y. The following data are extracted from the records of the company for a particular
given period.
Rs.
Rent and Taxes
25,000
General Lighting
3,000
Indirect Wages
7,500
Power
7,500
50,000
Sundries
50,000
Additional data departmentwise

Total
50000
15000
10000
15000
7500
2500
150
60
30
50
10
Cost of Machines (Rs. in Lakhs)
12.50
3.00
4.00
5.00
0.25
0.25
Floor Space (Sq.Mts.)
10000
2000
2500
3000
2000
500
Lighting Points (Nos.)
60
10
15
20
10
6226
4028
4066
Direct Wages (Rs.)

HP of Machines
Production Hours
Sundries can be apportioned on the basis of Direct Wages.

Service Departments expenses allocation A
20%
30%
40%
10%
40%
20%
30%
10%
Compute the overhead rate of production departments using repeated distribution method.
b.
Determine the total cost of a product whose direct material cost and direct labour cost
are Rs. 150 and Rs. 150 respectively and which would consume 4 hours, 5 hours and 3
hours in departments A, B and C respectively.
(13) Universal Ltd. has four production departments A, B, C and D and two service departments
viz. Transport and Power Supply.
330
Particulars of expenses of the respective departments are as follows :

A
Rs.
2,000
Rs.
1,800
Rs.
1,600
Rs.
1,400
Transport
Rs.
1,100
Power Supply
Rs.
760
The service departments expenses are charged out on a percentage basis as given below :
A
Transport
Power
Transport
10%
30%
20%
20%
20%
Power
30%
20%
30%
10%
10%
Using the above information, apportion the service department overheads to various production
departments using
a.
Simultaneous Equations Method
b.
Repeated Distribution Method
(14) A shop has 2 newly purchased machines, each occupying equal area of space. One is
4 - spindle drilling machine and the other is 6-spindle drilling machine costing Rs. 80,000
and Rs. 1,00,000 respectively. Following are the expenses for one year :
a.
Rent
Rs. 40,000
b.
Rates and Taxes
Rs. 17,000
c.
Lighting and heating
Rs. 12,600
d.
power expenses
- 4 spindle machine
Rs. 10,000
- 6 spindle machine
Rs. 15,000
e.
Administration expenses
Rs. 38,000
f.
Running and Maintenance
Rs. 80,000
The life of each machine is 10 years without any salvage value. Each machine works for 45
hours a week for 50 weeks in a year. 250 hours per machine are used for repairs. Running and
repairs expenses are shared between two machines on the basis of power expenses.
You are required to prepare statement showing computation of Machine Hour Rate.
Overhead Cost
331
(15) Calculate the machine hour rate in respect of machine No. 179 from the following
particulars :
Cost of machine
Rs. 20,000
Estimated Life
15,000 hours
Rs. 500/-
Estimated working hours per annum
2200
Estimated hours required for maintenance
100 (included in above)
Setting up time (Hours)
100 (included in above)
Power 20 units @ Rs.0.17 per unit

Repairs and maintenance per annum
Rs. 1500/-
No. of operators (looking after also 3 other machines)
Wages per operator per month
Rs. 150/-
Chemical required for operating the machine
Rs. 100/- p.m.
Overheads chargeable to the machine
Rs. 200/- p.m.
Insurance premium -1% p.a. on the cost of machine.
(16) You are required to calculate the composite machine hour rate from the following particulars
in respect of a jig boring machine whose scrap value is Rs. 50,000 after its working life of
10 years.
332
1.
Cost of the machine - Rs. 2,00,000
2.
Importation charges & Customs duty etc.- Rs. 50,000
3.
Working hours per year - 2,000
4.
Repairs & Maintenance charges - 50% of depreciation charge.
5.
Lubricating oil - Rs. 20 per working day of 8 hours
6.
Consumable stores - Rs. 500 per month of 25 working days.
7.
Power 10 units per working hour at Re. 0.30 per unit
8.
Wages of the operator - Rs. 1,000 per month of 25 working days.
(17) From the particulars furnished below, compute a machine hour rate :
Name of the Equipment - Single spindle Automat
Date of purchase
1.4.1983
Cost
Rs. 75,000
Estimated Life
10 years
Depreciation
15% on original cost
Insurance
Rs. 4,000 p.a.
Repairs
Rs.1,800 p.a.
Consumable stores
Rs. 1,500 p.a.
Rent
Rs. 2,400 p.a.
Superintendence
(l/5th for the machine)
Rs. 2,500 p.a.
The machine can work for 200 hours in a month and had actually worked for 80% of the normal
working hours. Cost of oils and greases consumed per hour is Rs.4.50,
(18) A dept. is having 3 machines. The figures indicate the departmental expense of these
machines. Calculate the machine hour rate from the data below :
Depreciation of machines
Rs.
12,000
Rent
Rs.
2,880
Repairs to machines
Rs.
4,000
Insurance of machines
Rs.
800
Indirect wages
Rs.
6,000
Power
Rs.
6,000
Lighting
Rs.
800
Misc. Expenses
Rs.
4,200
Rs
36,680
Overhead Cost
333
Other information :
M/c1
M/c2
M/c3
1,200
2,400
2,400
30,000
10,000
20,000
No. of workers
Light points
24
48
400
800
800
3,00,000
1,20,000
1,80,000
200
300
300
Direct wages Rs.

Power units
Space occupied (Sq. Ft.)

Cost of machine Rs.
Hours worked
(19) Following particulars relate to a machine :

Rs.
Purchase Price of machine
80,000
Installation Expenses
20,000
Rent per Quarter

General Lighting for the total area
3,000
200
per month
Supervisors salary
6,000
per quarter
Insurance premium
600
per annum
1,000
per annum
800
per annum
Estimated repairs
Estimated consumable stores
Power 2 units per hour @ Rs. 50 per 100 units
The estimated life of the machine is 10 years and the estimated scrap value is
Rs. 20,000. The machine is expected to run 20,000 hours in its life time. The machine
occupies 25% of the total area. The supervisor devotes l/6th of his time for the machine.
You are required to work out machine hour rate.
(20) From the following particulars, calculate the machine hour rate of machine installed in a
Department.
334
Cost of Machine
Rs. 16,000
Estimated scrap value after the expiry

of its life (15 years)
Rs. 1,000
Estimated working hours of the machine per year
2,000
Monthly salary of a foreman engaged in supervision

of this machine and other two identical machines.
Rs. 1,500
Repails and Maintenance of the machine
Rs. 2,400 per year
Insurance premium for the machine
Rs. 120 per year
Departmental rent and rates are Rs. 1,200 per year. The space occupied by the machine
is l/6th of the floor space of the department. Power consumption of the machine is 2
units per hour @ 10 paise per unit.
(21) A machine costing Rs. 20,000 is expected to work for 10 years and at the end of which
the scrap value is estimated Rs. 2,000, installation charges amount to Rs. 200. repairs
over 10 years life is expected Rs. l,800 and the machine is expected to run for 2.190
hours in a year.
Its power consumption would be 15 units per hour at Rs. 5 per 100 units. The machine
occupies l/4th of the area of the department and has two points out of ten for lighting. The
foreman has to devote l/3rd of his time for this machine. The rent for the department is
Rs. 300 p.m. and charges for lighting Rs. 80 p.m. The foreman is paid salary
Rs. 960 p.m. Find out the hourly rate assuming insurance is 1% per annum and expenses
on oil etc. Rs. 9 per month.
(22) Following data is available relating to a company for a certain month.

Territory
I
II
III
Selling Expenses (Rs.)
7,600
4,200
6,240
Distribution Costs (Rs.)
4,000
1,800
2,000
No. of units sold
16,000
6,000
10,000
Sales (Rs.)
76,000
28,000
52,000
The company adopts sales basis and quantity basis for application of selling and distribution
costs respectively.
Compute (a)
The territorywise overhead recovery rates separately for Selling and Distribution costs.
(b)
The amounts of selling and distribution cost chargeable to a consignment of 2,000 units
of a product, sold in each territory at Rs. 4.50 per unit.
Overhead Cost
335
(23) A machine is purchased for cash at Rs. 9,200. Its working life is estimated to be 18,000
hours after which its scrap value is estimated at Rs. 200. It is assumed from the past
experience that
a.
The machine will work for 1,800 hours annually.
b.
The repair charges will be Rs. 1,080 during the whole period for life of the machine.
c.
The power consumption will be 5 units per hour at 6 paise per unit.
d.
Other annual standing charges are estimated to be 1.
Rent of department (machine l/5th)
780
2.
Light (12 points in the department, 2 points engaged in the machine)
288
3.
Foremans salary (l/4th of his time is occupied in the machine)
4.
Insurance premium for machine
36
Cotton Waste
60
6000
Find out the machine hour rate on the basis of above data for allocation of the works expenses
to all jobs for which the machine is used.
(24) The following particulars relate to a new machine purchased.

Purchase Price of the machine
Rs. 4,00,000
Installation Expenses
Rs. 1,00,000
Rent per Quarter
Rs.
General Lighting for the total area
Rs.
Foremans Salary
Rs.
30,000 p.a.
Insurance Premium for the machine
Rs.
3,000 p.a.
Estimated repair for the machine
Rs.
5,000 p.a.
Estimated Consumable Stores
Rs.
4,000 p.a.
15,000
1,000 p.m.
The estimated life of the machine is 10 years and the estimated value at the end of 10 years
is Rs. 1,00,000. The machine is expected to run 20,000 hours in its life time. The machine
occupies 25% of the total area. The foreman devotes l/6th of his time for the machine.
Calculate the machine hour rate for the machine.
336
(25) A manufacturing unit has added a new machine to its fleet of five existing machines. The
total cost of purchase and installation of the machine is Rs. 7,50,000. The machine has
an estimated life of 15 years and is expected to realise Rs. 30,000 as scrap at the end
of its working life.
Other relevant data are as follows :
a.
Budgeted working hours are 2,400 based on 8 hours per day for 300 days. This includes
400 hours for plant maintenance.
b.
Electricity used by the machine is units per hour at a cost of Rs. 2 per unit. No current
is drawn during maintenance.
c.
The machine requires special oil for heating which is replaced once in every month at a
cost of Rs. 2,500 on each occasion.
d.
Estimated cost of maintenance of the machine is 500 per week of 6 working days.
e.
3 operators control the operations of the entire battery of six machines and the average
wages per person amounts to Rs. 450 per week plus 40% fringe benefits.
f.
Departmental and general overheads allocated to the operation during the last year were
Rs. 60,000. During the current year it is estimated that there will be an increase of
12.5% of this amount. No incremental overhead is envisaged for the installation of the
new machine.
You are required to compute the machine hour rate for the recovery of the running cost of the
machine.
(26) The following annual charges are incurred in respect of a machine in a shop where
manual labour is almost nil and where work is done by means of five machines of exactly
similar type and specification.
(a)
Rent and Taxes (Proportionate to the floor space occupied) for the shop - Rs. 4,803.
(b)
Depreciation on each machine - Rs. 500.
(c)
Repairs and maintenance for five machines - Rs. 1,000
(d)
Power consumed @ 6.25 paise per unit for the shop Rs. 3,750.
(e)
Electric charges for light in the shop - Rs. 540.
(f)
Attendants - There are two attendants for the five machines and they are each paid
Rs. 60 per month.
(g)
Supervision - There is one supervisor in the shop for the five machines and he is paid
Rs. 250 per month.
Overhead Cost
337
(h)
Sundry supplies such as lubricants, jute and cotton waste etc. for the shop - Rs. 494.
(i)
Hire Purchase - Instalment payable for the machine (including Rs. 300/- as interest) Rs. 1,200.
(j)
The machine uses 10 units of power per hour. Calculate the machine hour rate for the
year.
(27) In a manufactring concern ABC Ltd., die machine shop has 8 identical machines manned
by 6 operators. The machines cannot be worked without an operator wholly engaged on
them. The total cost of the machines are Rs. 8,00,000.
Following information relates to a six monthly period ended 30th June, 1990.
Normal available hours per month
208
Absenteeism (without pay) hours

per month.
18
Leave (with pay) hours per month
20
Normal idle time (unavoidable)

hours per month
10
Average rate of wages per day of 8 hours
Rs. 20
Production hours
15% on wages
Power and Fuel consumption
Rs. 9,000
Supervision and Indirect Labour
Rs. 3,300
Electricity
Rs. 1,200
The following particulars are on a yearly basis.

Repairs and Maintenance 3% of value of machines
Insurance
Rs. 42,000
Depreciation
10% of original cost.
Other factory expenses
Rs. 12,000
Allocated General Management

Expenses
Rs. 63,670
You are required to work out a comprehensive machine hour rate for the machine shop.
338
(28) In a factory, the following particulars have been extracted for the quarter ending 30th
June, 2001 in respect of Production Department P1, P2 and P3 and service Departments
S1 and S2. Compute the departmental overhead rate for each of the production
departments, assuming that overheads are absorbed as a percentage of direct wages.
Particulars
P1
P2
P3
S1
S2
Direct Wages (Rs.)
30000
45000
60000
15000
30000
Direct Material (Rs.)
15000
30000
30000
22000
22000
150
225
225
75
75
6000
4500
3000
1500
1500
Asset Value
60000
40000
30000
10000
10000
Light Points
10
16
150
250
50
50
50
No. of Workers
Power (KWHrs.)
Area in Sq. Fts.

Expenses for the period were
Power
Rs.
1,100
Lighting
Rs.
200
Stores overheads
Rs.
800
Staff Welfare
Rs.
3,000
Depreciation
Rs.
36,000
Rent
Rs.
550
General Overheads
Rs.
12,000
Apportion general overheads in the proportion of direct wages. Apportion the expenses of S1
according to direct wages and those of S2 in the ratio of 5 : 3: 2 to the production departments.
(29) A Ltd. has 3 production departments A, B and C and 2 service departments D and E.
The following are the figures of the company.
Rs.
Rent and Rates
5,000/-
General lighting
600/-
Indirect wages
1,500/-
Power
1,500/-
Depreciation of Machinery
10,000/-
Sundry Expenses
10,000/-
Overhead Cost
339
The following further details are available :

A
2000
2500
3000
2000
500
10
15
20
10
3000
2000
3000
1500
500
60,000
80,000
1,00,000
5,000
5,000
60
30
50
10
Floor Space (Sq.Ft)

Light points
Direct wages (Rs.)
Value of Machinery (Rs.)
H.P. of Machines
Sundry expenses are apportioted on the basis of direct wages

The expenses of D and E are allocated as under :
A
20%
30%
40%
10%
40%
20%
30%
10%
Find the rate per hour if the working hours are as under :
A
Department
6226
Department
4028
Department
4066
(30) In a light engineering factory, the following particulars have been collected for the three
monthly period ended 31.12.80. Compute the departmental overhead rates for each of
the production departments assuming that the overheads are recovered as a percentage
of direct wages.
Production Dept.
340
Service Dept.
Direct wages
Rs.
2,000
3,000
4,000
1,000
2,000
Direct materials
Rs.
1,000
2,000
2,000
1,500
1,500
Staff
Nos.
100
150
150
50
50
Electricity
Kwh.
4,000
3,000
2,000
1,000
1,000
Light points
Nos.
10
16
Asset value
Rs.
60,000
40,000
30,000
10,000
10,000
Area occupied
Sq.Ft.
150
250
50
50
50
The expenses for the period were :

Motive power
Rs.
550
Lighting power
Rs.
100
Stores overhead
Rs.
400
Amenities to staff
Rs.
1,500
Depreciation
Rs.
15,000
Rs.
3,000
General overheads
Rs.
6,000
Rent and Taxes
Rs.
275
Apportion the expenses of service dept. E proportionate to direct wages and that of service
dept. D in the ratio of 5 : 3 : 2 to depts A, B and C respectively.
Overhead Cost
341
NOTES
342
Chapter 11
MARGINAL COSTING
In the conventional system of cost ascertainment, the direct cost may be identified with the
individual cost center. However, the indirect costs i.e. the overheads are identified with the
individual cost center on the most equitable basis. This results into some problems in the
process of managerial decision-making.
a.
The above process does not take into consideration the behaviour of cost. All the costs
in the practical circumstances do not behave in the same manner. Some of the costs
tend to remain constant despite the changes in the level of activity or volume of operations.
These types of costs are comparatively irrelevant in the managerial decision-making.
b.
The above process results into the under absorption or over absorption of overheads.
The said limitations have given rise to a managerial decision making technique that basically
tries to classify the costs based upon the behaviour of cost. The technique is referred to as
Marginal Costing. The basic proposition made by this technique is that the costs should be
classified on the basis of behaviour of the costs. From this angle, the costs can be viewed as
fixed costs and variable costs,
Fixed Cost is the cost that tends to remain constant irrespective of the level of activity or
volume of operations. Fixed Cost tends to vary with time rather than with level of activity. Basic
characteristic feature of fixed cost is that this cost in terms of amount may remain constant at
all the levels of activities, however per unit fixed cost goes on decreasing with the increasing
level of activity and vice-a-versa.
Variable Cost is the cost that varies in direct proportion with the level of activity or volume of
operations. Basic characteristic feature of variable cost is that variable cost in terms of amount
may increase or decrease with the changing level of activity or volume of operations. However,
per unit variable cost remains constant.
In practical circumstances, some costs may not be entirely fixed or entirely variable. They are
technically in the form of semi-fixed costs or semi-variable costs. For the purpose of marginal
costing, the semi-fixed costs or semi-variable costs are required to be classified in the individual
Marginal Costing
343
components of fixed cost and variable cost. For segregating the semi-fixed or semi-variable
cost into the individual components of fixed cost and variable cost, various techniques or
methods may be available viz.
l
Comparison by period or level of activity
Range or High and Low method
Analytical method
Scattergraph method
Lease Square method
Based upon the above discussions, let us make some calculations for a manufacturing
organization manufacturing and selling a single product, operating at various levels of activities.
Level of Activity Units
1000
1500
2000
100
100
100
1,00,000
1,50,000
2,00,000
Variable Cost Rs.
60,000
90,000
1,20,000
Fixed Cost Rs.
30,000
30,000
30,000
Total Cost Rs.
90,000
1,20,000
1,50,000
Per Unit Variable Cost Rs.
Per Unit Fixed Cost Rs.
1.5
Per Unit Total Cost Rs.
7.5
Per Unit Selling Price Rs.

Total Sales Rs.
It can be observed from the above calculations that if the fixed cost is included in the calculation
of total cost, per unit total cost becomes non-comparable with the changes in the level of
activity in one cost-period to another cost-period. To avoid this non-comparability, it is necessary
to eliminate the fixed costs while determining the total cost.
As such, the technique of Marginal Costing proposes that fixed cost tends to remain stagnant
at least over a shorter period of time and hence should be ignored in the entire decision
making process. As such, marginal costing considers only the variable cost as the relevant
cost in the decision making process.
The Concept
Marginal Cost is defined as the amount at any given volume of output by which the aggregate
costs are changed if the volume of output is increased or decreased by one unit. The aggregate
cost consists of both fixed cost and variable cost. As in the short run, fixed costs remain
constant irrespective of changes in the volume, aggregate costs may increase or decrease
344
with the changes in volume, specifically due to variable cost. As such, in simple words,
marginal cost indicates Per Unit Variable Cost.
Marginal Costing is defined as the ascertainment, by differentiating between fixed and variable
costs, of the marginal costs and of the effect on profit of changes in volume and type of output.
Basic assumptions made by Marginal Costing
The entire technique of Marginal Costing is based upon the following assumptions.
a.
Variable Cost varies in direct proportion with the level of activity. However, per unit variable
cost remains constant at all the levels of activities.
b.
Per unit selling price remains constant at all the levels of activities.
c.
Whatever is produced by the organization is sold off. In other words, there are no variations
due to the stock.
Features of Marginal Costing

1.
The product costs are classified as fixed costs and variable costs. Semi-variable costs
are also classified in their individual components of fixed cost and variable cost.
2.
Only variable costs are considered while computing the product costs. The closing stock
of finished goods and semi-finished goods is valued after considering variable costs only.
3.
Fixed costs are written off during the period of incurrence and hence do not find the place
in product cost determination or inventory valuation.
4.
Prices of the product are based on variable costs only.
5.
Profitability of the products or departments is decided in terms of marginal contribution.
Marginal Costing and Cost-Volume-Profit Relationship

The definition of the term Marginal Costing requires the computation ofa.
Marginal Cost
b.
Cost-Volume Profit Relationship
a.
Determination of Marginal Cost

As stated earlier, the marginal cost is the additional cost for manufacturing one additional
unit, which is nothing else but the variable cost per unit. Thus the marginal cost or
variable cost includes the direct cost plus the variable overheads. Fixed overheads get
clubbed with the fixed cost.
Marginal Costing
345
b.
Cost Volume-Profit Relationship :

The intention of every business activity is to earn the profit and to maximize the profit.
Determination of the profits depends upon the interplay between the following factors
and there exists a close relationship among these factors :
(1)
Selling price per unit and total sales amount.
(2)
Total cost which in its turn may be in the form of variable cost or fixed cost.
(3)
Volume of sales
Cost-Volume-Profit Analysis aims at studying the relationships existing among these

factors and its impact on the amount of profits.
The relationships existing among these factors may be basically presented in two forms.
(a)
In statement or report form
(b)
In graphical form, the graphs or charts taking the form of break even chart, contribution
break even chart or profit chart.
Form of operating statement :

Under the marginal costing technique, the operating statement takes the form as specified
below.
(a)
In case of a single product company

Rs.
Sales
Less : Marginal cost

Direct Labour Cost
Direct Expenses
Variable Overheads
x
x
Contribution
Less : Fixed costs
Profit
346
x
x
x
(b)
In case of a multi product company

Product
A
Rs.
Product
B
Rs.
Product
C
Rs.
Total
Direct Material cost
Direct Labour cost
Direct Expenses
Variable Overheads
Sales
Rs.
Less : Marginal cost
Contribution
Less : Fixed costs
Profit
Basic concepts in Marginal Costing :

(1)
Basic equation of Marginal Costing :

The basic intention of the business is to earn the profit which is the excess of sales over
the total costs.
Profit = Sales - Total Cost
However, total cost can be either fixed cost or variable cost. As such the basic equation
takes the following forms.
Profit = Sales - (Variable Cost + Fixed Cost)
Profit = Sales - Variable cost - Fixed cost
Profit + Fixed cost = Sales - Variable cost.
This is the basic equation of marginal costing.
Both the expressions of Sales - Variable Cost and
Profit + Fixed cost are technically termed as contribution.
Sales - Variable Cost = Contribution = Fixed Cost + Profit
Contribution - Fixed cost = Profit
Marginal Costing
347
(2)
Contribution :
As discussed earlier, the term contribution can be expressed in two ways basically :
(a)
Sales - Variable Cost
(b)
Fixed cost + Profit
As in the short period, fixed costs are ineffective due to their stagnant nature, variable
cost becomes the most important cost in deciding the profitability. As such, the situation
which generates higher contribution is treated as profitable situation.
Further, the term contribution, plays an important role in a situation where there are more
than one products and the profits on individual products cannot be ascertained due to
the problems of apportionment of fixed costs to different products. This is due to the fact
that the fixed costs are ignored by marginal costing.
(3)
Profit Volume (P/V) Ratio :

This ratio indicates the contribution earned with respect to one rupee of sales. As such,
it is expressed as
Contribution
Sales
100
As in the short run, fixed cost remains the same, if there is any change in profits, that is
only due to change in contribution. Hence P/V ratio may also be expressed as :
Change in Profits
Change in Sales
100
E.g. Sales price is Rs. 10 per unit, variable cost is Rs.6 per unit, and fixed costs are
Rs.300, we observe that for 100 and 150 units, P/V Ratio works out as :
100 Units
Rs.
150 Units
Rs.
1,000
1,500
Variable cost
600
900
Contribution
400
600
Fixed cost
300
300
Profit
100
300
Sales
348
Hence, P/V Ratio is

Contribution
Sales
400
X
100
600
1,000
OR
i.e.
40%
100
i.e.
Increase in Profits
Increase in Sales
100
=
200
1,500
100
40%
X 100 = 40%
500
The fundamental property of P/V Ratio is that it remains constant at all the levels of
activities, provided per unit sales price and variable cost remains constant. It should be
noted that P/V Ratio remains unaffected by any variation in fixed costs though overall
profits may change due to this variation.
A high P/V Ratio indicates that a slight increase in sales without corresponding increase
in fixed costs will result in higher profits and vice-versa. This is a pointer to increased
sales promotion efforts to increase sales volume.
A low P/V Ratio indicates low profitability so that efforts can be made to increase the
profits by increasing selling price or by reducing variable cost. Overall profitability may
also be increased by concentrating more on products having high P/V Ratio.
Note : The basic expression of P/V Ratio i.e.Contribution/Sales may lead to other useful
conclusion as (a)
Sales x P/V Ratio = Contribution
(b)
Contribution
P/V Ratio
(4)
Sales
Break Even Point (BEP) :

This is a situation of no profit no loss. It means that at this stage, contribution is just
enough to cover the fixed costs i.e. Contribution = Fixed Cost. It also means that
contribution generated by all sales beyond Break Even Point will directly result into
profits. As such, it will be intention of every business to reach the Break Even Point, as
early as possible.
The Break Even Point may be expressed in two ways.
(a)
In terms of quantity
Fixed Costs
Contribution per unit
Marginal Costing
349
(b)
In term of amount
Fixed Costs
P/V Ratio
(5)
Margin of Safety :
These are the sales beyond Break even point. A business will like to have a high margin
of safety because this is the amount of sales which generates profits. As such, the
soundness of the business is indicated by the margin of safety. A high margin of safety
indicates that the Break Even Point is much below the actual sales and even if there is
reduction in sales, business will be still in profits. A low margin of safety accompanied
by high fixed cost and high P/V Ratio indicates that efforts are required to be made for
reducing the fixed cost or increasing sales volume. A low margin of safety accompanied
by a law P/V Ratio indicates that efforts are required to be made for reducing the variable
cost or increasing the selling price.
Margin of safety may be expressed as below :
Margin of Safety
Margin of Safety
Sales - Break Even Sales
Sales -
Fixed cost
P/V Ratio
Sales x P/V Ratio - Fixed Cost
P/V Ratio
Contribution - Fixed Cost
P/V Ratio
Profit
P/V Ratio
Margin of safety may be expressed as a ratio or as a percentage. E.g. If actual sales are
Rs.l,00,000 and Break Even Sales are Rs.60,000, Margin of Safety will be
Sales - Break Even Sales
Sales
i.e.
i.e.
350
1,00,000 - 60,000
1,00,000
100
40,000
100 =
1,00,000
100
40% of Sales
Illustrations :
(1)
Following details are available :

Sales
Rs.
Total Cost
Rs.
Period I
39,000
34,800
Period II
43,000
37,600
Calculate variable cost, fixed cost and contribution for each period.
Solution :
As Sales - Total Cost = Profit, we know as below :
Sales
Rs.
Total Cost
Rs.
Profit
Rs.
Period I
39,000
34,800
4,200
Period II
43,000
37,600
5,400
As P/V Ratio
Increase in Profits
Increase in Sales
X 100
1,200
5,400 - 4,200
43,000 - 39,000
X 100 =
4,000
X 100 = 30%
As Sales x P/V Ratio = Contribution,For period I, Contribution = 39,000 x 30% = 11,700

For period II, Contribution = 43,000 x 30% = 12,900
As Sales - Contribution = Variable Cost,
For period I, Variable Cost = 39,000 - 11,700 = 27,300
For period II, Variable Cost = 43,000 - 12,900 = 30,100
As Contribution - Profit = Fixed Cost,
For period I, Fixed Cost = 11,700- 4,200 = 7,500
For period II. Fixed Cost = 12,900 - 5,400 = 7,500
To summarise,
Period I
Rs.
Period II
Rs.
Contribution
11,700
12,900
Variable cost
27,300
30,100
7,500
7,500
Fixed cost
Marginal Costing
351
(2)
Following details arc available :

Sales
Rs.
Profit
Rs.
Period I
2,00,000
20,000
Period II
3,00,000
40,000
Find out Break even Sales

Solution :
We know that P/V Ratio
Increase in Profits
X 100
Increase in Sales
P/v Ratio
Margin of safety
20,000
100,000
X 100 = 20%
Profit
P/V Ratio
For period I, Margin of Safety is =
20,000
20%
= 1,00,000
As Break Even Sales = Sales - Margin of Safety.

Considering Period I,
Break Even Sales
(3)
2,00,000 - 1,00,000
1,00,000
Following details are available:

Actual Sales
Rs. 20,000
Break Even Sales Rs. 10,000

Fixed Cost
Rs.
5,000
Find out the profit at actual sales,

Solution :
At break Even Point, Contribution = Fixed Cost
At Break Even Point, sales are Rs. 10,000 and contribution Rs. 5,000
352
However we know that,

P/V Ratio
Contribution
100 =
Sales
5,000
X 100= 50%
10,000
We also know that. Sales x P/V Ratio = Contribution,

At actual sales of Rs. 20,000
Contribution
20,000 x 50%
5,000
We know that Contribution - Fixed cost = Profit
(4)
Profit
10,000 - 5,000
5,000
Following details are available:

Break Even Sales
Rs.
20,000
Fixed cost
Rs.
10,000
Profit
Rs.
5,000
Find out the margin of safety.

Solution :
At Break Even Point, Fixed Cost = Contribution
When sales are Rs. 20,000, Contribution is Rs. 10,000
However, we know that Contribution

Sales
P/V Ratio
X 100 =
10,000
P/V ratio
X 100 = 50%
20,000
We also know that,
Margin of safety
Marginal Costing
Profit
P/V Ratio
5,000
= 10,000
50%
353
(5)
Find, out the Break Even Point and Profit if sales are Rs. 50,00,000 and P/V Ratio is
50% and Margin of safety is 40%.
Solution :
Sales are Rs. 50,00,000 and Margin of safety is 40% of sales, hence margin of safety is Rs.
20,00,000. As Break Even Sales = Sales Margin of Safety.
BEP = Rs. 50,00,000 - Rs. 20,00,000 = Rs. 30,00,000
We know that,
Margin of Safety
Profit
P/V Ratio
Margin of Safety x P/V Ratio = Profit

As Margin of Safety is Rs. 20,00,000 and P/V Ratio is 50%,
Profit = 20,00,000 x 50% = 10,00,000
GRAPHICAL PRESENTATION OF COST-VOLUME-PROFIT RELATIONSHIPS
As discussed earlier, the Cost-Volume-Profit relationships may be expressed in the form of
visual aids like graphs and charts. There may be various ways in which these charts and
graphs can be prepared depending upon the purpose for which they are prepared. We will
discuss three of these ways.
(1)
Simple Break Even Chart

It can be prepared as below.
Y
TS
BEP
LOSS
FC
MOS
COST/REVENUE
TC
a
354
VOLUME
SL
TS
Total Sales Line
TC
Total Cost Line
BEP
Break Even Point
SL
Selected Level of Activity
FS
Fixed Cost
MOS
Margin of Safety
Angle a
Angle of Incidence.
Note : It will be observed from the above chart, that the angle formed by total sales line and
total cost line is termed as Angle of Incidence. As the difference between total sales and total
cost is in the form of profits, higher the angle of incidence better will be the situation.
The limitation of Simple Break Even Chart is that contribution cannot be shown separately. As
such, the following type of Break Even Chart may be prepared i.e. Contribution Break Even
Chart.
(2)
Contribution Break Even Chart :

This is a chart where the contribution is shown more clearly and specifically than in a
simple break even chart. It can be prepared as below.
TS
a
BEP
VC
FC
VC
MOS
COST/REVENUE
TC
VOLUME
SL
TS
Total Sales Line
PC
Fixed Cost
TC
Total Cost Line
VC
Variable Cost
BEP
Break Even Point
MOS
Margin Of Safety
SL
Selected Level of Activity
Angle a
Angle of Incidence.
Contribution
Marginal Costing
355
(3)
Profit Graph :
In case of this type of break even chart, horizontal axis represents sales volume and
vertical axis represents profit or loss. The diagonal line represents contribution. The
point where the contribution line cuts horizontal axis indicates sales at the Break Even
Point indicating that at this point, there is no profit or no loss.
PL
BEP
} FC
PL
FC
=
=
Profit Line
Fixed Cost
Profit Area
P
SALES
Loss Area
BEP
Break Even Point
PRACTICAL APPLICATIONS OF MARGINAL COSTING :

The technique of marginal costing can be profitably employed in the following situations.
(1)
Evaluation of Performance :
The performance of various segments of a business, say a department or a product or a
branch and so on, can be evaluated with the help of marginal costing and the evaluation
of the performance will be based upon the contribution generating capacity of these
segments. If the fixed costs are apportioned over these segments on any basis
whatsoever, it will be ignored while evaluating the performance.
356
Illustration :
Following details are available in respect of 3 products.
A
Rs.
Products
B
Rs.
C
Rs.
1,00,000
1,50,000
2,50,000
90,000
1,00,000
1,50,000
20,000
30,000
50,000
Total Cost
1,10,000
1,30,000
2,00,000
Profit (Loss)
(10,000)
20,000
50,000
Sales
Total Cost
Variable Cost
Fixed cost (Apportioned
on the basis of sales)
As product A is incurring the losses, it is decided to close down its production. Advise the
management,
Solution :
It will not be advisable to close down the production of product A, because it is generating the
positive contribution
(i.e. Rs. 1,00,000 - Rs. 90,000 = Rs. 10,000)
Closing down of product A will mean loss of contribution generated by it, fixed cost still
remaining the same. Assuming that the production of product A is closed down, what will be
the effect on profitability? Let us verify by applying marginal costing principles.
Product B
Rs.
Product C
Rs.
Total
Rs.
Sales
1,50,000
2,50,000
4,00,000
Variable Cost
1,00,000
1,50,000
2,50,000
50,000
1,00,000
1,50,000
Contribution
Fixed costs
Profits
1,00,000
50,000
It means that existing total profits of Rs. 60,000 will reduce to Rs. 50,000 which will affect
profitability adversely.
Marginal Costing
357
(2)
Profit Planning :
Marginal costing, through the calculations of P/V Ratio, enables the management to
plan the activities in such a way that the profits can be maximised or to maintain a
specific level of profits. As such, this technique helps the planning of profits.
Illustration :
(1)
M/s. C and P Ltd. Produces and sells industrial containers and packing cases. Due to
competition, the company proposes to reduce the selling price. If the present level of
profit is to be maintained, indicate the number of units to be sold if the proposed reduction
in price is (a) 10% and (b) 15%. The following information is available:
Rs.
(1)
Present Sales (30,000 Units)
(2)
Variable Cost (30,000 Units)
3,60,000
(3)
Fixed Cost
1,40,000
Rs.
6,00,000
5,00,000
(4)
Net Profit
1,00,000
Solution :
The present cost structure can be stated as below:
Per Unit
Rs.
Total
Rs.
Sales
20
6,00,000
Variable Cost
12
3,60,000
2,40,000
Contribution
Fixed Cost
1,40,000
Net Profit
1,00,000
If the price is reduced by 10% or 15%, the per unit cost structure is going to change
as below :
358
Present
10% Price Reduction
15% Price Reduction
Rs.
Rs.
Rs.
Sales
20
18
17
Variable Cost
12
12
12
Contribution
If the present level of profits is to be maintained i.e. Rs. 1,00,000, the revised total contribution
which the sales will have to generate with reduced per unit contribution will be Expected Profit
+ Fixed Cost, and the number of units which will have to be sold will be :
Expected Profit + Fixed Cost
Revised per unit contribution
As such, the number of units which will have to be sold in the above cases of price reduction
will be 10% Price Reduction
15% Price Reduction
Rs. 1,00,000 + Rs. 1,40,000
Rs. 1,00,000 + Rs. 1,40,000
Rs. 6
Rs. 5
=
=
(2)
Rs. 2,40,000
Rs. 2,40,000
=
Rs. 6
40,000 Units
Rs. 5
48,000 Units
Per Unit cost structure of a single product manufacturing company is as below :

Selling Price
Rs.
100
Direct Material
Rs.
60
Direct Labour
Rs.
10
Variable overheads
Rs.
10
Number of Units sold in the year are 5,035. As per the agreement with the employees
union, there will be an increase of 10% in Direct wages.
Work out (a)
How many more units have to be sold next year to maintain same quantum of
profits.
(b)
By what percentage the selling price has to be raised to maintain same P/V Ratio?
Marginal Costing
359
Solution :
The present profitability structure is as below :
(i)
Total number of units sold
(ii)
Per unit cost structure
5,035
Selling price
Rs. 100
Variable cost
Direct Material
Rs. 60
Direct Labour
Rs. 10
Variable Overheads
Rs. 10
Rs. 80

(iii) Total Contribution
Rs. 20
Rs. 1,00,700
In the next year, the per unit Direct Labour Cost will be more by 10% i.e. Rs. 11 per unit which
will reduce the per unit contribution to Rs. 19.
Alternative (a) :
If the same quantum of profits is to be maintained, same amount of contribution will have to be
generated with reduced per unit contribution.
As such, number of units required to be sold will be :
=
=
=
Amount of contribution
Revised per unit contribution
Rs. 1,00,700
Rs. 19
5.300 Units
Hence, the company will have to sell 265 units more (i.e. 5,300 Units - 5,035 Units) to maintain
same quantum of profits.
Alternative (b) :
At present, when selling price is Rs. 100, contribution is Rs. 20 meaning that per unit variable
cost is Rs. 80.
In future, the variable cost is likely to be Rs. 81 per unit instead of Rs. 80. Accordingly, the
selling price will also be required to be increased if it is intended that the same P/V Ratio
should be maintained.
360
The new selling price will be :

Rs. 81
Rs. 80
100 = Rs. 101.25
As such, the selling price has to be raised by 1.25% to maintain the same P/V Ratio.
The profitability structure will be Selling Price
Rs. 101.25
Variable Cost
Rs. 81.00
Contribution
Rs. 20.25
P/V Ratio
20.25
101.25
(3)
X 100
Selling Price per unit

X
100 = 20%
Fixation of Selling Price :

The technique of marginal costing may be applied in the area of price fixation in such a
way that prices fixed should cover atleast the variable cost. As in the short run, the fixed
cost is a stagnant cost, it can be ignored, though it can not be ignored in the long run
because of the simple fact, that it is a cost. In the short run, the prices fixed above the
variable cost may generate some positive contribution which may help in the recovery of
fixed cost. However, if the fixed cost is ignored in the long run, it may put the business
into serious troubles as the business will never be able to earn the profits.
In this connection, following propositions should be kept in mind.
(a)
In some exceptional circumstances viz. during the phase of depression, serious

competition in the market, to introduce the new product in the market by keeping
the price as low as possible in the initial stages, to dispose off the product which
may deteriorate in quality etc., it may be necessary to fix the selling price even
below the variable cost, however it is a deliberate decision taken by the management.
(b)
The above principle is equally applicable while fixing the export price as well. The
export price over and above the variable cost will result into increased amounts of
profits if the fixed costs can be taken care of by the inland sales and if the home
market is not likely to get affected by the export price fixed. However, if certain
specific costs, either fixed or variable, are required to be incurred specifically for the
execution of the export order, they will have to be recovered while fixing the export
price as if it is a part of the variable cost.
Marginal Costing
361
Illustration :
(1)
The operating statement of a company is as follows :

Rs.
Sales (80,000 Units @ Rs. 15)
12,00,000
Costs Variable
Materials
2,40,000
Labour
3,20,000
Overheads
1,60,000
7,20,000
Fixed
Total Costs
Profit
3,20,000
10,40,000
1,60,000
The plant capacity is 1,00,000 units. A customer from U.S.A. is desirous of baying 20,000
units at a net price of Rs. 10 each unit. Advice the company whether or not offer should be
accepted? Will your advice be different if the customer is a local one?
Solution :
At present, variable cost per unit is Rs. 9 i.e.
Rs. 7,20,000
80,000 units
So long as the export price is more than Rs. 9, it is going to generate additional contribution
which is going to increase the profits, as the fixed costs are already covered by the local
sales. As the export price offered is Rs. 10 i.e., Re. 1 more than the variable cost per unit, the
company should accept the offer. The advice will be the same even it the customer is a local
one, provided the price discrimination, i.e. Rs. 15 per unit for 80,000 units and Rs. 10/- per unit
for 20,000 units is not going to adversely affect the current market for 80,000 units at the
current price of Rs. 15. If the company accepts the export offer of Rs. 10 per unit, the revised
profitability structure will be as below:
Rs.
Sales :
80,000 units @ Rs. 15
12,00,000
20,000 units @ Rs. 10
2,00,000
14,00,000
362
Costs
Variable
1,00,000 units @ Rs. 9
9,00,000
Fixed
3,20,000
Total costs
12,20,000
Profit
1,80,000
The revised amount of profit will be more by Rs. 20,000 as compared to the existing amount of
profits. Hence, the export order should be accepted by the company.
(4)
Make or buy decision :

If the management is facing problem to decide whether a component or a product should
be manufactured in house which can be purchased from an outside source as well, the
technique of marginal costing may render useful assistance. E.g. The following cost
data is made available in respect of two components A and B.
Component A
Rs. per unit
Component B
Rs. per unit
Variable Cost
30
30
Fixed Cost
25
20
55
50
40
25
If manufactured
If purchased
If the above data is viewed from total cost point of view, without considering the
classification of cost like fixed or variable, it may be concluded that the purchase
proposition may be profitable for both the components A and B. However, the conclusion
may be misleading as the total cost in case of component A, if purchased, is not going
to be only Rs. 40 per unit, but it is going to be Rs. 65 (i.e. Rs. 40 purchase price per unit
plus Rs. 25 fixed cost per unit) which being more than present total cost, manufacturing
proposition will be beneficial. On the other hand, in case of component B, total cost, if
purchased, is going to be Rs. 45/- per unit (i.e. Rs. 25 purchase price per unit plus Rs.
20 fixed cost per unit) which being less than present total cost, buying proposition will be
beneficial.
The above conclusions may be simplified in the following way :
If Purchases Price < Variable Cost, go in for purchase proposition.
If Purchase Price > Variable Cost, go in for manufacturing proposition.
Marginal Costing
363
Before taking any make or buy decision only on the basis of marginal cost analysis,
following points should also be taken into consideration.
(5)
(1)
If buying proposition is beneficial in case of a component or product, the final decision

to buy may depend on other factors also viz. whether the supplier is reliable one,
whether the supplier can assure required quality, whether the supplier can assure
uninterrupted supply etc.
(2)
If it is decided to buy a component or a product which was being manufactured till

now, the manufacturing capacity released should be profitably used for some other
purposes. If it is decided to manufacture a companent which was being purchased
till now, there may be two possibilities. One, production capacity used for same
component or product may be diverted to manufacture another component or
product. In this case, the loss of contribution of that another component or product
should be considered as a part of cost. Second, if additional production facilities
are required to be acquired for the manufacturing proposition, the additional fixed
costs attached with the manufacturing proposition should be considered.
Optimising product mix :

Product mix refers to the proportion in which various products of a company can be sold.
If a concern is dealing in a number of products, a problem which usually arises is to
decide a mix or proportion in which the sales of the various products should be made so
that the profits can be maximized. Such a problem can be solved by studying the
contributions generated by the various products individually and by selecting that mix
which generates the maximum total contribution.
Illustration :
Following information has been made available from the cost records of Universal Automobiles
Ltd. manufacturing spare parts
Direct Materials per unit
X
Rs. 8
Y
Rs. 6
Direct wages
X
Y
24 hours @ 25 paise per hour.

16 hours @ 25 paise per hour.
Variable overheads - 150% of wages

Fixed overheads - Rs. 750
Selling price
X
Y
364
Rs. 25
Rs. 20
The Directors want to be acquainted with the desirability of adopting any one of the following
alternative sales mixes in the budget for the next period.
(a)
250 units of X and 250 units of Y
(b)
400 units of Y only
(c)
(d)
State which of the alternatives you would recommend to management.

Solution :
Productwise Profitability Structure
Product X
Rs.
Product Y
Rs.
25
20
Direct Material
Direct Wages
Variable Overheads
23
16
(1)
(2)
Variable cost per unit
(3)
Evaluation of various alternative sales mixes as per Total Contribution

Alternative
Product X
Rs.
Product Y
Rs.
Total
Rs.
a.
250 x 2 = 500
250 x 4 = 1,000
1,500
b.
400 x 4 = 1,600
1,600
c.
400 x 2 = 800
100 x 4 = 400
1,200
d.
150 x 2 = 300
350 x 4 = 1,400
1,700
Fixed overheads are going to be the same in all these alternatives. As such, the alternative
which generates maximum contribution is the maximum profitable one.As alternative d i.e.
150 units of X and 350 mills of Y generates maximum of contribution, it will be recommended
to the management.
Marginal Costing
365
(6)
Cost control :
Marginal costing is necessarily a technique of cost classification and cost presentation.
The segregation of total costs as fixed costs and variable costs itself facilitates the cost
control. Variable costs are the controllable costs at the lower level of management whereas
fixed costs can be controlled only on the top level of management and that too, to a
limited extent only. Classification of costs as fixed costs and variable costs enables the
management to concentrate on the controllable costs. At the same time, the fixed costs
are not completely ignored. The only thing is that they are collected and reported separately
as an amount deducted from total contribution. As such, the fixed costs can also be
controlled as they can be programmed and estimated in advance.
(7)
Flexible Budget Preparation :

Marginal costing technique and more particularly the classification of costs as fixed and
variable, facilitates the preparation of flexible budgets which is discussed in details in the
chapter Budgetary Control.
PROBLEM OF KEY FACTOR :

Under the marginal costing technique, profitability is measured in terms of the contribution
and the products generating maximum contribution or having maximum P/V Ratio are treated
as the maximum profitable products. As the intention of every business is to maximize the
profits, the company will concentrate maximum on the products having highest P/V Ratio and
will thus maximize the profits. However, in practice, there may be some factors which may
come into play which may restrict the companys intention or capability to maximize the
profits E.g. In case of the products having highest P/V Ratio, market may be limited, or in
case of a maximum profitable product, raw material may not be available. These factors are in
the form of Key Factor or Limiting Factor or Scarce Factor. A key factor is defined as the
factor which, at a particular point of time or over a period, will limit the volume of output. The
key factor may be in various forms viz. sales/market, material, labour, machine availability and
so on. In order to evaluate the profitability of a product under key factor situations, the contribution
per unit of key factor is the basic criteria. A product generating maximum contribution per unit
of key factor is the maximum profitable product.
366
Illustration :
From the following details, which product would be recommended if time is the key factor.
Product A
Product B
Direct Material per unit
Rs. 24
Rs. 14
Direct Labour @ Rs. 2 per hour
Rs. 20
Rs. 30
200%
300%
Rs. 150
Rs. 200
Product A
Product B
150
200
Direct Material
24
14
Direct Labour
20
30
Variable Overheads
40
90
84
134
Variable Overheads (% of labour cost)

Solution :
(1)
Selling Price Unit Rs.
(2)
Variable Cost per unit Rs.
(3)
Contribution per unit Rs.
66
66
(4)
Number of labour hours
10
15
(5)
Contribution per labour hour Rs.
6.6
4.4
As labour hours is the key factor and contribution per labour hour is more in case of product A,
it will be recommended for production.
Multiplicity of Key Factors
In practice, more than one key factors may come into play and any decision regarding product
mix ascertainment or profitability ascertainment will have to be decided on the basis of
consideration of multiplicity of key factors. The situation of multiplicity of key factors is a more
complex situation, the solutions to which may be found in the more advanced techniques like
linear programming.
Marginal Costing
367
Illustration :
Following data is available to decide the product mix.
Raw material per unit

Labour Hours required
10 kgs
6 kgs
15 kgs.
15
25
20
125
100
200
6,000
4,000
3,000
(Rate Rs. 1 per hour)

Selling price per unit Rs.
Maximum production
Possible Units
1,00,000 kgs of raw material is available at Rs. 10 per kg. Maximum production hours are
1,84,000 with a facility for a further 15,000 hours on overtime basis at twice the normal wage
rate.
Solution :
Product A
Product B
Product C
125
100
200
Material
100
60
150
Labour
15
25
20
115
85
170
10
15
30
(1)
Selling Price per units Rs.
(2)
Variable cost
(3)
(4)
Contribution per Kg of Raw material - Rs.
1.00
2.50
2.00
(5)
Contribution per labour hrs Rs.
0.66
0.60
1.50
Considering the contribution per kg of raw material as well as per labour hour, the rankings
among the various products will be as below.
I
Product C
II
Product B
III
Product A
Hence, the available raw material and labour hours will be used for the manufacture of Product
C and Product B respectively.
368
Product
Units
Raw Material Kgs.
Labour Hours No.
3,000
45,000
60,000
4,000
24,000
1,00,000
69,000
1,60,000
Hence, the balance of raw material and labour hours available for manufacturing of Product A
will be as below.
Raw Material - Kgs. -
31,000 kgs.
(i.e. 1,00,000 kgs - 69,000 kgs)
Labour Hours - 24,000 (i.e. 1,84,000 - 1,60,000)

Plus 15,000 extra hours by paying double the normal wage rate.
If extra labour hours are used for the manufacture of product A by paying double the normal
wage rate, the cost structure of product A will be as below :
(1)
(2)
(3)
Rs.
125
Material
Rs.
100
Labour
Rs.
30
Rs.
130
(-) Rs. 5
As there cannot be the positive contribution generated, it will not be advisable to use the
labour hours which require the payment of wages at double the normal wage rate. As such,
product A will be manufactured by utilising the labour hours which require the payment of
wages at the normal wage rate only i.e. 24,000 hours with the help of which 1,600 units of A
(24,000 Hours/ 15 Hours per unit) can be manufactured. As such, the final product mix will be
as below.
Product A
1,600 Units
Product B
4,000 Units
Product C
3,000 Units
Note : One alternate solution is possible to solve the problem of key factors. If the labour
hours which require the payment of wages at double the normal wage rate can be utilised for
the manufacture of Product C, its cost structure will be as below.
Marginal Costing
369
(1)
Selling Price Per Unit
(2)
Rs. 200
Material
Rs. 150
Labour
Rs.
40
Rs. 190
(3)
Rs.
10
As such, apparently it may be possible to utilise the labour hours carrying double the normal
wage rate for manufacturing product C and utilise the released labour hours carrying the
normal wage rate for manufacturing Product A (i.e. 15,000 hours) In this case, the final product
mix will be as below.
Product A
2,600 Units
Product B
4,000 Units
Product C
3,000 Units
The calculation of total contribution generated under both those alternatives is as below.
Alternative I
Product
No. of Units
Contribution
Per Unit Rs.
Total Contribution
Rs.
1,600
10
16,000
4,000
15
60,000
3,000
30
90,000
1,66,000
Alternative II
Product
No. of Units
Contribution
Per Unit Rs.
Total Contribution
Rs.
2,600
10
26,000
4,000
15
60,000
2,250
30
67,500
750
10
7,500
1,61,000
As in the second alternative, the total contribution generated is less than the one generated in
the first alternative, the second alternative can not be accepted. As such, it will be advisable
for the company not to utilise the labour hours requiring the payment of wages at double the
normal wage rate.
370
LIMITATIONS OF MARGINAL COSTING

(1)
The classification of total cost as variable cost and fixed cost is difficult. No cost can be
completely variable or completely fixed. In some cases, the cost which is considered to
be variable, may not be variable in practical terms E.g. Direct Labour Cost. Under normal
situations this cost is treated as variable cost. However, in India, considering the
tremendous legal backing the workers are having, the direct labour cost may not be
variable in nature. As such, it may be necessary to consider the direct labour cost as a
part of fixed cost.
(2)
Under the marginal costing, the fixed costs are eliminated for the valuation of inventory of
finished goods and semi-finished goods, inspite of the fact that they might have been
actually incurred. As such, it is not correct to eliminate the fixed costs. Further, such an
elimination affects the profitability adversely.
(3)
In the age of increased automation and technological development, the component of

fixed costs in the overall cost structure may be sizeable. Any technique like marginal
costing which ignores the fixed costs altogether, may not be proper under these
circumstances as a major portion of cost is not taken care of.
(4)
Marginal costing technique does not provide any standard for the evaluation of performance.
In that sense, the techniques of budgetory control and standard costing may be considered
to be better techniques from cost control point of view.
(5)
Fixation of selling price on marginal cost basis may be useful for short term only. Here
also, an undue importance given to only variable cost may result into taking on heavy
business with low margin which in turn may increase the fixed costs. As such, over the
long run, the prices should be decided on total cost basis only. Fixation of selling price
on the marginal cost basis in the long run may be dangerous. Moreover, consideration of
fixed costs may be necessary in price fixation under certain circumstances like cost
plus contracts unless a very high percentage over the marginal cost is considered to
take care of both fixed costs as well as profit margin.
(6)
Marginal costing does not take into consideration the fixed overheads, as such the
problem of under or over absorption of fixed overheads can be avoided. But the problem
of under or over absorption of variable overheads cannot be avoided.
(7)
Marginal costing can be used for assessment of profitability only in the short run. However,
in the long run, one has to consider the fixed costs also in order to assess the profitability.
Moreover, interpretation of the term short run is a subjective concept. For how long the
decision can be taken on the basis of marginal costing principles cannot be decided in
the objective manner.
Marginal Costing
371
(1)
Profit and sales for the year 1984 are as follows. Profit Rs. 18,000, Sales Rs. 2,40,000.
In 1985, the sales increased by Rs. 40,000 and the profit naturally increased by Rs.
8,000.
You are required to calculate.

(1)
P/V Ratio
(2)
Sales required to achieve a profit of Rs. 1,00,000.
(3)
Sales at Break even Point.
Solution :
We know that
P/V Ratio
Increase in Profits
X 100
Increase in Sales
P/V Ratio
8,000
X 100 = 20%
...(a)
40,000
We also know that Sales x P/V Ratio = Contribution
and Contribution - Profit = Fixed Cost.
Applying this to the information available for the year 1984
2,40,000 x 20% = Rs. 48,000 is the contribution and
48,000 - 18,000 = Rs .30,000 is the fixed cost
If the company wants to achieve the profit of Rs. 1,00,000 the total contribution which will have
to be generated will be Expected Profit + Fixed cost
i.e. Rs. 1,00,000 + Rs. 30,000
i.e. Rs. 1,30,000
We know that Sales =
Contribution
P/V Ratio
As such sales required to achieve a profit of Rs. 1,00,000 will be

P/V Ratio
372
1,00,000 + 30,000
20%
1,30,000
Rs. 6,50,000
...(b)
20%
We know that
Break Even Point
Fixed Cost
P/V Ratio
Sales at Break Even Point
30,000
20%
= Rs. 1,50,000
(2)
(c)
The Directors of Sports Material Manufacturing Co. gives the following information.
Sales - (1,00,000 Units)
- Rs.
1,00,000
Variable Costs
- Rs.
40,000
Fixed Costs
- Rs.
50,000
(a)
Find out P/V Ratio, Break Even Point and Margin of Safety.
(b)
Evaluate the effects on P/V Ratio, Break Even Point and Margin of safety of the
following (i)
20% increase in physical sales volume.
(ii)
10% increase in fixed costs.
(iii)
5% decrease in variable costs.
(iv)
10% increase in selling price.
Solution :
(A) Present profitability structure is as below.
Sales - 1,00,000 Units
Per Unit (Rs.)
Total (Rs.)
Sales
1.00
1,00,000
Variable Costs
0.40
40,000
Contribution
0.60
60,000
Fixed Costs
50,000
Profit
10,000
Marginal Costing
373
(1)
P/V Ratio
Contribution
Sales
(2)
100
60,000
1,00,000
50,000
60%
Rs. 83,333
10,000
60%
Rs. 16,667
100 = 60%
Break Even Point

Fixed Cost
P/V Ratio
(3)
Margin of Safety
Profit
P/V Ratio
(B) Effect of 20% increase in Physical Sales Volume. Revised Profitability structure will be
as below.
Sales 1,20,000 Units
Per Unit (Rs.)
Total (Rs.)
Sales
1.00
1,20,000
Variable Costs
0.40
48,000
Contribution
0.60
72,000
Fixed Costs
50,000
Profit
22,000
(1)
P/V Ratio
Contribution
Sales
(2)
X 100
50,000
60%
Rs. 83,333
22,000
60%
Rs. 36,667
60%
Margin of Safety
Profit
P/V Ratio
374
72,000
1,20,000
100
Break Even Point

Fixed Cost
P/V Ratio
(3)
(C) Effect of 10% increase in fixed costs. Revised profitability structure will be as below :
Per Unit (Rs.)
Total Rs.
Sales
1.00
1,00,000
Variable Costs
0.40
40,000
Contribution
0.60
60,000
Fixed Costs
55,000
Profit
(1)
5,000
P/V Ratio
Contribution
Sales
(2)
100
60,000
1,00,000
55,000
60%
Rs. 91,667
5,000
60%
Rs. 8,333
100
60%
Break Even Point

Fixed Cost
P/V Ratio
(3)
Margin of Safety
Profit
P/V Ratio
(D) Effect of 5% decrease in variable costs. Revised profitability structure will be as below.
Per Unit (Rs.)
Total (Rs.)
Sales
1.00
1,00,000
Variable Costs
0.38
38,000
Contribution
0.62
62,000
Fixed Costs
50,000
Profit
12,000
(1)
P/V Ratio
Contribution
Sales
Marginal Costing
100
62,000
1,00,000
X 100
62%
375
(2)
Break Even Point

Fixed Cost
P/V Ratio
(3)
50,000
62%
Rs. 80,645
12,000
62%
Rs. 19,355
Margin of Safety
Profit
P/V Ratio
(E) Effect of 10% increase in selling price. Revised Profitability structure will be as below.
Per Unit (Rs.)
Total (Rs.)
Sales
1.10
1,10,000
Variable Costs
0.40
40,000
Contribution
0.70
70,000
Fixed Costs
50,000
Profit
20,000
(1)
P/V Ratio
Contribution
Sales
(2)
50,000
63.64%
Rs. 78,567
20,000
63.64%
Rs. 31,426
100
63.64%
Break Even Point

Fixed Cost
P/V Ratio
(3)
70,000
1,10,000
100
Margin of Safety
Profit
P/V Ratio
Note : The difference between Sales and Break Even Point is not matching with Margin of
Safety, due to the rounding off differences.
(3)
376
From the following figures find out the break even volume.
Selling Price per tonne
Rs. 69.50
Variable Cost per tonne
Rs. 35.50
Fixed Expenses
Rs. 18,02,000
If this volume represents 40% capacity, what is the additional profit for an added production of
40% capacity, the selling price of which is 10% lower for 20% capacity production and 15%
lower, than the existing price, for the other 20% capacity.
Solution :
Selling Price per Unit
Rs. 69.5
Variable cost per Unit
Rs. 35.5
Contribution per Unit
Rs. 34.0
Break Even Point
Fixed Cost
(in terms of quantity)

=
=
Rs. 18,02,000
Rs. 34
53,000 Units
Additional production of 53,000 units is envisaged, which can be classified in two parts for
convenience purposes.
Part I
Part II
Rs. 62.55
59.075
Variable Cost per Unit
Rs. 35.50
35.500
Rs. 27.05
23.575
26,500
26,500
7,16,825.00
6,24,737.50
Number of Units
Total Contribution Rs.
As the fixed cost is already covered till the break even point, the contribution beyond the break
even point will directly result into profit. Hence, additional profit will be Rs. 7,16,825.00 +
Rs. 6,24,137.50 = Rs. 13,41,562.50.
(4)
The Quality Product Ltd. manufacture and markets a single product Following data is
available.
Rs. Per Unit
Material
16
Conversion (Variable)
12
Dealers Margin
Selling Price
40
Fixed Cost - Rs. 5,00,000

Present Sales - 90,000 Units
Capacity Utilisation - 60%
Marginal Costing
377
There is acute competition. Extra efforts are necessary to sell. Suggestions have been made
for increasing sales.
(a)
By reducing sales price by 5%.
(b)
By increasing dealers margin by 25% over the existing rate.
Which of these two suggestions would you recommend if the company desires to maintain
present profits. Give reasons.
Solution :
The present profitability statement will be as below, when 90,000 units are being sold.
Per Unit (Rs.)
Total (Rs.)
40
36,00,000
Material
16
14,40,000
Conversion
12
10,80,000
3,60,000
32
28,80,000
7,20,000
(a)
Sales
(b)
Variable Costs
Dealers Margin
(c)
Contribution a b
(d)
Fixed cost
5,00,000
(e)
Profit c d
2,20,000
Alternative I To reduce selling price by 5%. In this alternative the profitability structure will be
revised as below.
Rs. 38
Rs. 32
Rs. 06
If the company wishes to maintain the same profits, the total contribution which the sales will
have to generate with the reduced amount of per unit contribution will be Expected Profits +
Fixed Cost. And total number of units to be sold will be No. of Units to be sold
=
=
378

Revised contribution per Unit
2,20,000 + 5,00,000
6
1,20,000 Units
Alternative II To increase the dealers margin by 25%. In this alternative, the variable cost will be more by
Rs. 1 and the profitability structure will be revised as below.
Rs. 40
Rs. 33
Rs. 07
If the company wishes to maintain the same profits, the total contribution which the sales will
have to generate with the reduced amount of per unit contribution will be Expected Profits +
Fixed Cost. And total number of units to be sold will be No. of Units to be sold

Revised contribution per unit
2,20,000 + 5,00,000
7
1,02,857 Units
Acute competition in the market is the basic problem area. As such, the company will like to
accept the alternative where less number of units will be required to be sold, the profits
remaining the same under both the alternatives.
As Alternative II requires 1,02,857 Units to be sold vis-a-vis 1,20,000 units required to be sold
under Alternative I, the company will prefer Alternative II.
Note : It is assumed that both the alternatives are exclusive alternatives i.e. Even when selling
price is reduced by 5%, the dealers margin is unaffected and vice versa.
(5)
Frazer Ltd. manufactures and sells a product, the selling price and raw material cost of
which have remained unchanged during the past two years. The following are the relevant
data:
Particulars
Year 1
Year 2
100
150
Sales Value
Rs. 20,000
Raw Material
Rs. 10,000
Direct Wages
Rs. 3,000
Factory Overheads
Rs. 5,000
Rs. 5,700
Profit
Rs. 2,000
Rs. 2,550
Quantity sold (Kgs.)
Marginal Costing
379
During year 2, direct wage rates increased by 50% but there was a saving of Rs. 300 in fixed
factory overheads.
Required :
What quantity in Kgs. the company should have produced and sold in year 2 in order to
maintain the same amount of net profit per Kg. as it earned during the year 1?
Solution :
The Profitability statement for both the years is as below Year 1
Year 2
100
150
20,000
30,000
Raw Material
10,000
15,000
Direct Wages
3,000
6,750
Variable Factory Overheads
2,000
3,000
15,000
24,750
Contribution
5,000
5,250
Fixed Cost
3,000
2,700
Profit
2,000
2,550
20
17
Quantity Sold (Kgs.)

Sales (Rs.)
Variable Cost
Total Variable Cost
Profit per Kg. (Rs.)
Per Unit Variable Cost in Year 2 works out to Rs. 165 i.e. Rs. 24,750 / 150 Kgs.
Let us assume that the quantity to be sold in Year 2 is X Kgs.
Hence, the profitability statement will be 200X - 165X - 2700 = 20X
Solving for X, we get the value of X to be 180 Kgs.
Hence, the company should have produced and sold 180 Kgs. in year 2 in order to maintain
the same amount of net profit per Kg. as it earned during Year 1.
Working Note Factory Overheads in Year 1 were Rs. 5,000 which became Rs. 5,700 in Year 2 with the
information that there was a saving of Rs. 300 in fixed factory overheads. Assuming that there
was no saving, the factory overheads would have been Rs. 6,000 in Year 2. Hence, the data
would have been as below -
380
Year 1
Year 2
100
150
5,000
6,000
Quantity Sold (Kgs.)

Factory Overheads (Rs.)
For the increased quantity of 50 Kgs. the overheads would have increased by Rs. 1,000. It
means that the variable factory overheads are Rs. 20 per unit.
(6)
Garden Products Limited manufacture the Rainpour garden pour. The accounts of the
company for the year 1981 are expected to reveal a profit of Rs. 14,00,000 from the
manufacture of Rainpour after charging fixed costs of Rs. 10,00,000. The Rainpour is
sold for Rs.50 per unit and has a variable unit cost of Rs. 20. Market sensitivity tests
suggest the following responses to price changes.
Alternatives
A
Selling Price
Reduced by
5%
Quantity sold
increased by
10%
7%
20%
10%
25%
Evaluate these alternatives and state which, on profitability consideration, should be adopted
for the forthcoming year, assuming cost structure unchanged from 1981.
Solution :
At present, the expected profit is Rs. 14,00,000 after recovering the fixed cost of Rs. 10,00,000.
Hence, the total expected contribution is Rs. 24,00,000 i.e. Rs. 14,00,000 + Rs. 10,00,000.
Per Unit cost structure is as below.
Selling Price
Rs. 50
Variable Cost
Rs. 20
Contribution Rs. 30
If total contribution is Rs. 24,00,000 and per unit contribution is Rs. 30, it means that the
presently expected sales in terms of quantity are 80,000 units.
Marginal Costing
381
In the light of above, the results of the various alternatives can be calculated as below.
Alternatives
Revised Selling
Revised contribution
Revised sold
Revised total
Price Per Unit

1
Per Unit
2
Per Unit
3
Quantity
4
contribution
5(3x4)
47.50
27.50
88,000
24,20,000
46.50
26.50
96,000
25,44,000
45.00
25.00
100,000
25,00,000
As profitability is the criteria on which the various alternatives are to be evaluated, Alternative
B will be selected, as it generates maximum contribution, fixed cost remaining the same
under all the alternatives.
(7)
Shri Kiron manufactures Lighters. He sells his product at Rs. 20 each and makes profit
of Rs. 5 on each lighter. He worked 50% of his machinery capacity at 50,000 lighters.
The cost of each lighter is as under.
Rs.
Direct Material
Wages
Works Overheads
5 (50% fixed)
Sales Expenses
2 (25% variable)
His anticipation for the next year is that the cost will go up as under.
Fixed Charges
10%
Direct Labour
20%
Material
5%
There will not be any change in selling price. There is an additional order for 20,000 lighters in
the next year.
What is the lowest rate he can quote so that he can earn the same profit as the current year?
382
Solution :
The profitability statement in the current year is as below :
Sales 50,000 Units
Per Unit (Rs.)
Total (Rs.)
20.00
10,00,000
Direct Material
6.00
3,00,000
Wages
2.00
1,00,000
Works overheads
2.50
1,25,000
Sales Expenses
0.50
25,000
11.00
5,50,000
9.00
4,50,000
Works Overheads
2.50
1,25,000
Sales Expenses
1.50
75,000
(A) Sales
(B) Variable Costs
(C) Contribution (A B)
(D) Fixed Costs
2,00,000
(E) Profits (C D)
2,50,000
In the next year, material cost will increase by 5% i.e., by 30 paise and direct labour cost will
increase by 20% i.e., by 40 paise. As such, the total variable cost will increase by 70 paise.
Hence, the total variable cost will be Rs. 11.70 per unit. The revised profitability structure for
50,000 unit will be :
Selling price per unit
Rs. 20.00
Rs. 11.70
Total contribution
Rs. 8.30
Rs. 4,15,000
In the next year, fixed charges will increase by 10% i.e., total fixed charges of Rs. 2,00,000 in
this year will become Rs. 2,20,000.
As we know that Contribution - Fixed Charges = Profit, the profit generate by 50,000 units will
be
Rs. 4,15,000 Rs. 2,20,000 = Rs. 1,95,000
Marginal Costing
383
If in the next year, the company wants to earn the same total profits as in the current year i.e.
Rs. 2,50,000 there will be a shortfall of Rs. 55,000 i.e., Rs. 2,50,000 - Rs. 1,95,000 and the
shortfall will have to be recovered by additional 20,000 units proposed to be sold in the next
year. Hence, over and above the variable cost, each of these additional units will have to
recover the profit of :
Rs. 55,000
20,000 units
Rs. 2.75 per Unit
Hence, the lowest rate which can be quoted will be : Expected variable cost per unit in the
next year + Expected profit per unit in the next year
i.e., Rs. 11.70 + Rs. 2.75 = Rs. 14.45 per unit
(8)
Following details are available in respect of a single product manufacturing company

operating at 75% capacity.
Units Sold
15,000
Selling Price Per Unit
Rs. 12.5
Material Cost
Rs. 3 per Unit
Labour hours required
2 per unit
Labour hour rate
Re. 1 per hour
Variable expenses
200% of labour cost
Fixed cost
Rs. 20,000
The company has received an offer to export 8,000 units. Due to the Government backing, the
material will be available at a price lower by 25% than the existing price. An additional expenditure
of Rs. 10,000 will have to be incurred for execution of this export order. But an export incentive
is available from the Government which will be equivalent to 25% of the export price. What
minimum price should be charged if it is intended that per unit exported should earn a clear
margin of Rs. 2 and the profits from inland sales remaining the same. Ignore the benefits
available as per the provisions of Income Tax Act, 1961 and the time required to receive the
export incentive in cash since the date of actual export. Assume that Selling price in inland
market cannot be increased.
384
Solution :
Present cost structure is as below:
Sales -15,000 Units
Per Unit (Rs.)
Total (Rs.)
12.50
1,87,500
Material Cost
3.00
45,000
Labour Cost
2.00
30,000
Variable Expenses
4.00
60,000
9.00
1,35,000
3.50
52,500
(A)
Selling price
(B)
Variable Costs
(C)
Contribution (A - B)
(D)
Fixed Cost
20,000
(E)
Profit (C D)
32,500
When sales are 15,000 Units, capacity utilisation is 75%. It means that maximum 20,000
units can be sold both in inland or export market. The export order received is for 8,000 units.
Now, the company has two alternatives.
Alternative I :
Accept the export order only for 5,000 units which can be manufactured.
Alternative II :
Accept the export order for 8,000 units by reducing the inland sales by
3,000 units.
Alternative I :
Only 5,000 Units to be exported.
The amounts which export price will have to cover are as below:
Per Unit (Rs.)
Material Cost
2.25
Labour Cost
2.00
Variable Expenses
4.00
Additional Expenditure (Rs. 10,000

distributed over 5,000 units)
2.00
Expected margin
2.00
12.25
The above amount can be covered either by way of export price of the export incentive which
is 25% of export price. If we assume export price to be Rs. x, the following relationship is
established.
Marginal Costing
385
+ 25% of
12.25
x
4
12.25
i.e.
5x
4
12.25
i.e.
9.80
i.e.
Hence, export price should be minimum Rs. 9.80.

Alternative II :
8,000 units to be exported, inland sales being only 12,000 units.If 8,000 units are to be
exported, inland sales will be less by 3,000 units, which will result in the loss of contribution
of Rs. 10,500 (i.e. 13000 units x Rs. 3.50 per unit) This loss of contribution also will have to be
covered by the units to be exported, as the selling price in the inland market can not be
increased. As such per unit amount to be covered by export price is as below:
Rs. 12.25 (As calculated in Alternative 1) plus
Rs. 10,500
Rs. 1.3125
8,000 units
= Rs. 12.25 + Rs. 1.3125
= Rs. 13.5625
This amount can be covered either by way of export price or by export incentive, which is 25%
of export price. Assuming export price to be Rs. x,
x + 25% of x
13.5625
x+
x
4
13.5625
5x
4
= 13.5625
10.85
Hence export price should be minimum Rs. 10.85
386
(9)
A Ltd. operating at 75% level of activity produces and sells two products X and Y. The
cost sheets of these two products are as under :
Particulars
Product X
Product Y
3,000
2,000
115
95
Direct Materials
10
20
Direct Labour
20
20
Factory Overheads (40% fixed)
25
15
40
25
95
80
Units produced and sold

Selling Price Per Unit (Rs.)
Cost :
Administration & Selling

Overheads (60% fixed)
Total Cost Per Unit
Factory overheads are absorbed on the basis of machine hour rate which is the limiting factor.
The machine hour rate is Rs. 10 per hour.
The company receives an offer from Japan for the purchase of Product X at a price of Rs. 87.50
per unit. Alternatively, the company has another offer from Bangkok for the purchase of Product
Y at a price of Rs. 77.50 per unit. In both the cases, a special packing charge of Rs. 2.50 per
unit has to be borne by the company. The company can accept either of the two export orders
by utilising the balance of 25% of its capacity.
Advise the company with the detailed workings as to which proposal should be accepted and
prepare a statement showing the overall profitability of the company after incorporating the
export proposal suggested by you.
Solution :
The existing profitability structure as per marginal costing works out as below Product X
Product Y
115
95
Direct Materials
10
20
Direct Labour
20
20
Factory Overheads
15
Administration & Selling Overheads
16
10
61
59
54
36
Selling Price
Variable Cost -
Contribution
Marginal Costing
387
Hence, Total Contribution Product X - 3000 Units x Rs. 54 per unit =
Rs. 1,62,000
Product Y - 2000 Units x Rs. 36 per unit =
Rs. 72,000
Rs. 2,34, 000
Fixed Cost can be calculated as below:

Product X - 3000 Units x Rs. 34 per unit =
Rs. 1,02,000
Product Y - 2000 Units x Rs. 21 per unit =
Rs. 42,000
Rs. 1,44,000
Hence, profit i.e. Contribution - Fixed Cost Rs. 90,000. As Factory Overheads as absorbed on
the basis of machine hour rate and as machine hour rate is Rs. 10, Product X takes 2.5 hours
and Product Y takes 1.5 hours. Hence, the total number of hours consumed by the existing
level of activity can be calculated as below:
Product X - 3000 Units x 2.5 hours per unit =
7,500 hours
Product Y - 2000 Units x 1.5 hours per unit =
3,000 hours
10,500 hours
As 10,500 hours are equivalent to 75% level of activity, balance number of hours available for
the execution of the export order are 3,500 which is equivalent to balance 25% level of activity.
With the balance number of hours available, the maximum number of units which can be
manufactured for export order work out as below:
Product X - 3,500 hours / 2.5 hours per unit = 1,400 units
Product Y - 3,500 hours / 1.5 hours per unit = 2,333 units
The contribution generated by the units to be exported can be worked out as below :
Product X
Product Y
Selling Price
(Net of packing charge)
85
75
Variable Cost
61
59
Contribution
24
16
Total contribution generated by executing the export order can be worked out as below:
Product X - 1400 Units x Rs. 24 per unit = Rs. 33,600
Product Y - 2333 Units x Rs. 16 per unit = Rs. 37,328
388
As the contribution generated by exporting Product Y is higher, it will be profitable to export

Product Y. Hence, the total profitability works out as below:
Existing Profits
Rs. 90,000
Contribution generated by exports
Rs. 37,328
Total Profits
Rs. 1,27,328
(10) A Ltd. manufactures three different products and the following information has been
collected from the books of account.
Sales Mix
Selling Price
Variable Cost
Total Fixed costs
Total Sales
Product
T
35%
Rs. 30
Rs. 15
35%
Rs. 40
Rs. 20
30%
Rs. 20
Rs. 12
Rs. 1,80,000
Rs. 6,00,000
The company has currently under discussion a proposal to discontinue the manufacture of
product Y and replace it with product M, when the following results are anticipated:
Sales Mix
Selling Price
Variable Cost
Total Fixed Cost
Total Sales
Product
T
50%
Rs. 30
Rs. 15
25%
Rs. 40
Rs. 20
25%
Rs. 30
Rs. 15
Rs. 1,80,000
Rs. 6,40,000
Will you advice the company to changeover to production of M? Give reasons for your answer.
Solution :
PRESENT PROFITABILITY STRUCTURE :
(1)
(2)
(3)
(4)
(5)
(6)
Sales
Units Sold (1/2)
Total Contribution (4X5)
= Rs. 2,82,000
Marginal Costing
S
Rs.
Product
T
Rs.
Y
Rs.
2,10,000
30
15
15
7,000
1,05,000
2,10,000
40
20
20
5,250
1,05,000
1,80,000
20
12
8
9,000
72,000
389
PROPOSED PROFITABILITY STRUCTURE :
(1)
(2)
(3)
(4)
(5)
(6)
Sales
Units Sold (1/2)
Total contribution (4X5)
= Rs. 3,20,000
S
Rs.
Product
T
Rs.
M
Rs.
3,20,000
30
15
15
10,667
1,60,005
1,60,000
40
20
20
4,000
80,000
1,60,000
30
15
15
5,333
79,995
As the total contribution in the proposed alternative i.e. to change over to production of M is
likely to be more than in the present situation, the company should change over to production
of M.
(11) The budgeted results of A Co. Ltd. include Product
Sales Value (Rs.)
P/V Ratio (%)
50,000
50
80,000
40
1,20,000
30
Fixed overheads for the period were Rs. 1,00,000. The Directors are worried about the results
of the company. They have requested you to prepare a statement showing the amount of loss
expected and recommend a change in the sales of each product or in total mix which will
eliminate the expected loss.
Solution :
We know that (1)
Sales x P/V Ratio = Contribution
(2)
Contribution - Fixed Cost = Profit

Product
A
B
C
390
Sales Value (Rs.)
P/V Ratio
Contribution
50,000
80,000
1,20,000
50%
40%
30%
25,000
32,000
36,000
2,50,000
93,000
Less Fixed Cost

Profit
1,00,000
(-) 7,000
Hence, the expected loss is Rs. 7,000.

To eliminate the expected loss, the sales of individual products may be increased, depending
upon the P/V Ratio. The additional sales required to be achieved will be calculated as Loss to be eliminated
P/V Ratio
Hence, additional sales will be as below :
Product A - 7,000/50% = Rs. 14,000.
Product B - 7.000/40% = Rs. 17,500.
Product C - 7,000/30% = Rs. 23,333.
As an alternative, the overall sales may also be increased to eliminate the expected loss as
stated below:
At present, overall P/V Ratio is Contribution
Sales
100
93,000
2,50,000
100 =
37.2%
To cover the expected loss, the additional sales which will be required to be made will be Expected Loss
Overall P/V Ratio
7,000
Rs. 18,817
37.2 %
These additional sales may be increased in the existing proportion only i.e. 50,000 : 80,000 :
1,20,000. Hence, the productwise additional sales and the contribution generated by these
additional sales will be as below :
Product
Additional Sales
Rs.
P/V Ratio
Contribution
Rs.
3,763
50%
1,882
6,021
40%
2,408
9,033
30%
2,710
18,817
7,000
(12) A Ltd. been producing a standard mix as below :

Product X 15,000 units.
Product Y and Z 10,000 units.
Marginal Costing
391
The total variable costs amount to Rs. 2,09,000 and the variable cost ratio among the products
is 1 : 1.5 : 1.75 respectively per unit The fixed, charges amount to Rs. 2 per unit. Selling prices
are Rs. 6.40 for X, Rs. 7.60 for Y and Rs. 10.70 for Z.
It is desired to change the mix as below :
Product
Mix 1
Mix 2
Mix 3
18,000
15,000
22,000
12,000
6,000
8,000
7,000
13,000
8,000
Which mix should be recommended?

Solution :
The variable cost ratio among products X, Y and Z is I : 1.5: 1.75 respectively per unit. If all the
products are expressed in terms of Product X, it can be as below :
Product X
15,000 units
Product Y
15,000 units (10,000 x 1.5)
Product Z
- 17,500 units (10,000 x 1.75)

47,500 Units
Total Variable cost is Rs. 2,09,000.

Hence, per unit variable cost will be as below:
Product X -
Rs. 2,09,000
Rs. 4.40
Rs. 6.60
Rs. 7.70
47,500
392
Product X -
Rs. 4.40
X 1.5
Product Z -
Rs. 4.40 X 1.75
Product X
Rs.
Product Y
Rs.
Product Z
Rs.
Selling Price
6.40
7.60
10.70
Less : Variable Cost
4.40
6.60
7.70
Contribution
2.00
1.00
3.00
The total contribution generated by various alternative mixes will be as below :

MIX 1
Rs.
18,000 x 2
36,000
12,000 x 1
12,000
7,000 x 3
21,000
69,000
Mix 2
X
15,000 x 2
30,000
6,000 x 1
6,000
13,000 x 3
39,000
75,000
Mix 3
X
22,000 x 2
44,000
8,000 x 1
8,000
8,000 x 3
24,000
76,000
As Mix 3 generates maximum contribution, it will be recommended. Fixed cost will be ignored,
as it will be same under all the circumstances.
(13) A firm can produce three different products from the same raw material using the same
production facilities. The requisite labour is available in plenty at Rs.8 per hour for all the
products. The supply of raw material which is imported at Rs.8 per Kg. is limited to
10,400 Kgs. for the budget period. The variable overheads are RS.5.60 per hour. The
fixed overheads are Rs. 50,000. The selling commission is 10% on sales.
a.
From the following information, you are required to suggest the most suitable sales
mix which will maximise the firms's profits. Also determine the profit that will be
earned at that level :
Product
Market Demand
Units
Selling Price
Per unit (Rs.)
Labour Hours
Per Unit (Rs.)
Raw Material
Per Unit (Kgs.)
8,000
30
0.7
6,000
40
0.4
5,000
50
1.5
1.5
b.
Assume, in the above situation, if additional 4,500 Kgs of raw material is made
available for production, should the firm go in for further production, if it will result in
Marginal Costing
393
the additional fixed overheads of Rs.20,000 and 25% increase in the rates per hour
for labour and variable overheads ?
Solution :
The profitability statement is as below :
X
27.00
36.00
45.00
Raw Material
Direct Labour
Variable Overheads
5.60
8.00
5.60
3.20
16.00
11.20
12.00
12.00
8.40
Total Variable Cost
19.20
30.40
32.40
7.80
5.60
12.60
11.14
14.00
8.40

(Net of commission)
Variable Cost per unit

Contribution per Kg. of
Raw Material
As availability of raw material is the key factor, the order of preference among the products will
be Y, X and Z.
6,000 units of Y consume 2,400 Kgs. of material.
Balance left for X and Z are 8,000 Kgs.
8,000 units of X consume 5,600 Kgs. of material.
Balance left for Z are 2,400 Kgs.
With 2,400 Kgs. of material, maximum possible production for Z will be 1,600 units i.e.
2,400 / 1.5
Hence, the most suitable sales mix and said sales mix will be Product
Y
X
Z
Less : Fixed Cost
Profit
394
No. of Units
6,000
8,000
1,600
Contribution
Per Unit
Rs.
5.60
7.80
12.60
Total Contribution
Rs.
33,600
62,400
20,160
1,16,160
50,000
66,160
If additional 4,500 Kgs. of raw material is made available, the additional 3,000 units of Z can be
sold. However, the profitability per unit of Z will be different as below :
Selling Price
45.00
Variable Cost
Direct Material
12.00
Direct Labour
15.00
Variable Overheads
10.50
Total Variable Cost
37.50
Contribution
7.50
Total Contribution generated by these 3,000 units will be Rs. 22,500 i.e. 3,000 units x Rs. 7.50
per unit. As the fixed overheads are also likely to increase by Rs. 20,000, the additional 3,000
units will generate positive contribution of Rs. 2,500. Hence, it is advisible to go for further
production with the additional raw material available.
(14) The following particulars are obtained from the records of a factory manufacturing Products
A and B.
Product A
(Per unit)
Product B
(Per Unit)
100
200
Material Cost at Rs. 10 per Kg.
20
50
Wages @ Rs. 3 per hour
30
60
Variable overheads
10
20
Selling Price
Total fixed costs : Rs. 5,000

State which of the product is better to be produced and why in the following cases:
(a)
If total sales in units is key factor
(b)
If total sales in value is key factor
(c)
If law material is in short supply
(d)
If labour hours is the Limiting factor
(e)
If raw material available is 2,000 kgs. and maximum sales of each product is 500 units,
advice about the sales mix.
Marginal Costing
395
Solution :
Product A
Per Unit
Rs.
Product B
Per Unit
Rs.
100
200
Material
20
50
Wages
30
60
Variable Overheads
10
20
60
130
40
70
40%
35%
2 Kgs.
5 Kgs.
20
14
10
20
3.5
(1)
Selling Price
(2)
Variable cost :
(3)
Contribution (1 - 2)
(4)
P/V ratio (3/1)
(5)
Material consumption
Contribution per kg. of material

(3/5)
(6)
Labour Hours
Contribution per labour hour

(3/6)
(a)
If total sales in units is the key factor, Product B will be better as its per unit
contribution is more.
(b)
If total sales in value is the key factor, Product A will be better as its P/V Ratio is
more.
(c)
If raw material is in short supply, Product A will be better as its contribution per Kg.
of material is more.
(d)
If labour hours is the limiting factor, Product A will be better as its contribution per
labour hour is more.
(e)
If total available raw material is 2,000 Kgs., it will first utilised to manufacture Product
A as its contribution per Kg. of material is more. However the maximum sales
potential of Product A is restricted to 500 units which consumes 1,000 Kgs. of
material (i.e. 500 units x 2 Kgs. per unit). Remaining material of 1,000 Kgs. can be
used for the manufacture of Product B, with the help of which only 200 units of
Product B can be manufactured i.e.,
1,000 Kgs
5 Kgs. per Unit
396
= 200 Units
Hence, the desirable product mix will be

500 units of Product A
200 units of Product B
(15) Small-Tools Factory has a plant capacity adequate to provide 19,800 hours of machine
use. The plant can produce all A type tools or all B type tools or a mixture of the two
types. The following information is relevant.
Per Type
Selling Price Rs.
10
15
Variable Cost Rs.
12
Hours required to produce
Market conditions are such that no more than 4,000 A type tools and 3,000 B type tools
can be sold in a year. Annual fixed costs are Rs. 9,900.
Compute the product mix that will maximize the net income to the company and find
that maximum net income.
Solution :
It is a situation of multiplicity of key factors, first key factor being availability of machine hours
and second one being market conditions. The contribution per machine hour can be computed
as below :
A
Selling Price Per unit Rs.
10
15
Variable cost per mat Rs.
12
0.66
0.75
II
Machine hours required per unit
Contribution per machine your Rs.
Ranking when machine hours availability is key factor
As such, tool B will be produced to the maximum possible extent i.e. 3,000 units and the
balance machine hours should be utilised for the production of tool A.
Marginal Costing
397
The net income can be worked out as below:

Tool
Units
Machine hours
required
Contribution
per unit
Rs.
Total
contribution
Rs.
3,000
12,000
9,000
2,600
7,800
5,200
19,800
14,200
Less : Annual fixed costs
9,900
Net Profit
4,300
(16) An umbrella manufacturer makes an average net profit of Rs. 2.50 per piece on a selling
price of Rs. 14.30 by producing and selling 6,000 pieces or 60% of the potential capacity.
His cost of sales is as follows:
Direct material
Direct wages
Works overheads
Sales overheads
Per Unit
Rs. 3.50
Rs. 1.25
Rs. 6.25 (50% fixed)
Rs. 0. 80 (25% varying)
During the current year, he intends to produce the same number but anticipates that his fixed
expenses will go up by 10% while rate of direct labour and direct material will increase by 8%
and 6% respectively. But he has no option of increasing the selling price. Under this situation
he obtains an offer for a further 20% of capacity. What minimum price will you recommend for
acceptance to ensure the manufacturer an overall profit of Rs. 16,730?
Solution :
Profitability structure
Previous year
398
Current Year
Per Unit
Rs.
Total
Rs.
Per Unit
Rs.
Total
Rs.
14.30
85,800
14.30
85,800
Direct Material
3.50
21,000
3.71
22,260
Direct Wages
1.25
7,500
1.35
8,100
Works Overhead
3.125
18,750
3.125
18,750
Sales Overheads
0.20
1,200
0.20
1,200
8.075
48,450
8.385
50,310
(1)
Selling Price
(2)
Variable Cost
Previous year
Per Unit
Total
Rs.
Rs.
(3)
Contribution (1 2)
(4)
Fixed Cost
(5)
Current Year
Per Unit
Total
Rs.
Rs.
6.225
37,350
5.915
35,490
Works Overheads
3.125
18,750
20,625
Sales Overheads
0.60
3,600
3,960
3.725
22,350
24,585
2.50
15,000
10,905
Profit (3 4)
From the above, it can be seen that the present sales of 6,000 units will generate a total profit
(after recovering the fixed cost) of Rs. 10,905. If it is intended that the overall profit should be
Rs. 16,730, there will be a shortfall of Rs. 5,825 which will have to be covered by the additional
2.000 units to be sold. As such, every additional unit to be sold will have to generate a clear
margin of Rs. 2.9125 i.e., Rs. 5,825/2,000 units.
Hence the minimum price to be recommended will be Revised per unit variable cost + Expected
per unit margin i.e., Rs. 8.385 + Rs. 2.9125
i.e., Rs. 11.2975
(17) The cost profile of a company, manufacturing only one product, is as under :
Rs.
Direct Material
5.60
Direct Labour
1.50
Variable factory overheads
0.40
7.50
Fixed factory overhead is budgeted at Rs. 3,30,000 for an annual sales of 4,00,000 units.Selling,
Distribution and Administration costs are budgeted at Rs. 1,80,000.
Capital employed is Rs. 4,50,000 in fixed assets and 50% of sales in current assets.
Determine a selling price for the product to yield 20% return on capital employed.
Solution :
Let us assume that the selling price per unit is Rs. X. Hence, total sales will be
Rs. 4,00,000 X.
Marginal Costing
399
The total amounts to be covered by this amount of sales will be Rs.

Variable Cost - 4,00,000 x 750
30,00,000
Fixed Factory overheads
3,30,000
Selling Distribution and Administration cost
1,80,000
Profit
90,000 + 40,000 x
36,00,000 + 40,000 x
Note :
Profit is calculated as below :
Expected yield - 20% of capital employed where
Capital employed
Hence, Profit
4,50,000 + 50% of sales
4,50,000 + 50% of 4,00,000 x
4,50,000 + 2,00,000 x
20% (4,50,000 + 2,00,000 x)
90,000 + 40,000 x
Thus,
4,00,000 x = 36,00,000 + 40,000 x
= 3,60,000 x = 36,00,000
x = Rs. 10
Hence the selling price for the product should be Rs. 10 per unit.
(18) V Ltd. produces two products P and Q. The draft budget for the next month is as
under.
P
40,000
80,000
Selling Price Rs / Unit
25
50
Total Costs Rs / Unit
20
40
Machine Hours / Unit
60,000
100,000
Budgeted Production and sales (Units)
Maximum Sales Potential (Units)
The fixed expenses are estimated at Rs. 9,60,000 per month. The company absorbs fixed
overheads on the basis of machine hours which are fully utilised by the budgeted production
and cannot be further increased.
400
When the budget was discussed, the Managing Director stated that the product mix should
be altered to yield optimum profit.
The Marketing Director suggested that he could introduce Product C, each unit of which will
take 1.5 machine hours.
However, a processing vat involving a capital outlay of Rs. 2,00,000 is to be installed for the
processing of product C. The additional fixed overheads relating to the processing vat was
estimated to be Rs. 60,000 per month. The variable cost of Product C was estimated of Rs.
21 per unit.
Required (i)
Calculate the profit as per draft budget for the next month.
(ii)
Revise the product mix based on data given for P and Q to yield optimum profit.
(iii) The company decides to discontinue either product P or Q whichever is giving lower
profit and proposes to substitute product C instead. Fix the selling price of Product C
in such a way so as to yield 15% return on additional capital employed besides maintaining
the same overall profits as envisaged in (ii) above.
Solution :
At present, the utilisation of the machine hours is as below.
Product P - 40,000 units x 2
80,000 Hrs.
Product Q - 80,000 units x 1
80,000 Hrs.
1,60,000 Hrs.
Fixed Expenses are Rs. 9,60,000 per month and are absorbed on the basis of utilisation of
machine hours.
Hence, Machine Hour Rate
Rs. 9,60,000
= Rs. 6/Hr.
1,60,000 Hrs.
As such, the fixed overheads absorbed by the product (which must have been included in the
total cost.) are as below :
Product P - 2 Hrs. x Rs. 6 = Rs. 12
Product Q - 1 Hr. x Rs. 6 = Rs. 6
Marginal Costing
401
Hence, the cost structure of the products can be amended as below :

Product P
Rs.
Selling Price / Unit
Less : Variable cost
Fixed Cost
Product Q
Rs.
Rs.
25
50
34
12
Total Cost
Profit
(1)
Rs.
20
40
10
Profit as per draft budget for the next month are

(a)
Sales - P - 40,000 Unit x Rs. 25/ Unit
Rs. 10,00,000
Q - 80,000 Units x Rs. 50/ Unit
Rs. 40,00,000
Rs. 50,00.000
(b)
Variable Cost - P - 40,000 Units x Rs. 8/ Unit
Rs. 3,20,000
Q - 80,000 Units x Rs. 34/ Unit
Rs. 27,20,000
Rs. 30,40.000
(2)
(c)
Contribution a b
(d)
Fixed Expenses
(e)
Profit c d
Rs. 19,60,000
Rs. 9,60,000
Rs. 10,00,000
Revised Product Mix to yield Optimum Profit.

The machine hours are available in limited quantity and hence are the key factor of
production.
The revised cost structure of the products is as under.
Prod. P
Prod Q.
Selling Price - Rs./ Unit
25
50
Variable Cost - Rs./ Unit
34
Contribution Rs./ Unit
17
16
Machine Hours/ Unit
8.5
16
Contribution Rs./ Machine Hour
As the contribution per unit of key factor i.e. Machine Hour is more in case of Product Q, the
available machine hours will be utilised for the manufacture of Product Q subject to its maximum
sales potential.
402
Thus, the revised product mix will be:

Product
Machine Hours
Machine
Hours/Unit
Units
Product Q -
1,00,000 Units x 1 Hr. = 1,00,000
1,00,000
Product P -
1,60,000 Hrs. 1,00,000 Hrs. = 60,000
30,000
The revised profitability will be (a)
Sales - Q 1,00,000 Units x Rs. 50/ Unit

- P 30,000 Units x Rs. 25/ Unit
Rs. 50,00,000
Rs. 7,50,000
Rs. 57,50,000
(b)
Variable Cost - Q 1,00,000 Units X Rs. 34/ Unit

P 30,000 Units x Rs. 8/ Unit
Rs. 34,00,000
Rs. 2,40,000
Rs. 36,40,000
(c)
Contribution a-b
Rs. 21,10,000
(d)
Fixed Expenses
Rs. 9,60,000
(e)
Profit c-d
(3)
Calculation of Selling Price of Product C :
Rs. 11,50,000
The various amounts to be covered by the sales of product C are as below:

Variable cost - 40,000 Units x Rs. 21/ Unit
Rs. 8,40,000
Fixed Expenses to be absorbed 40,000 Units x Rs. 6/ Machine Hour x 1.5 Hrs/ Unit
Additional fixed overheads
Rs. 3,60,000
Rs. 60,000
Yield on capital employed

15% on Rs. 2,00,000
Deficit of Profit
Rs. 30,000
Rs. 1,50,000
Rs. 14,40,000
Hence, the per unit selling price will beRs. 14,40,000

40,000 units
Marginal Costing
= Rs. 36/ Unit
403
Notes :
(1)
As availability of machine hours is the key factor and the contribution per machine hour
is less in case of Product P, it will be discontinued. Production of Product Q will be
continued subject to its maximum sales potential. As such, 1,00,000 units of product Q
will be produced and sold, thus leaving 60,000 machine hours for the production and
sales of product C. As one unit of product C consumes 1.5 Machine Hours, maximum
40,000 units of product C can be produced and sold i.e.,
60,000 Machine Hours
1.5 Machine Hrs./Unit
(2)
It is assumed that Product Q will continue to absorb the fixed expenses at the current
rate of absorption. Hence, the profit generated by product Q will be as below:
(a)
Sales - 1,00,000 Units x Rs.50/ Unit Rs. 50,00,000
(b)
Variable Cost - 1,00,000 Units x Rs. 34/ Unit Rs. 34,00,000
(c)
Contribution - a-b Rs. 16,00,000
(d)
Fixed Expenses absorbed 1,00,000 units x Rs. 6/ Machine Hr. Rs. 6,00,000
(e)
Profit c-d Rs. 10,00,000

As the profit is desired to be maintained at Rs. 11,50,000 the deficit should be
covered by the sales of product C
(3)
404
As the fixed overhead relating to the processing vat will be incurred specifically due to
Product C, it will be as if the variable cost of Product C.
QUESTIONS
1.
What do you understand by the terms Break Even Point, Contribution and Margin of
Safety? Explain your answer by drawing a chart with assumed figures.
2.
How does Break Even Analysis help in business decisions?
3.
Describe the importance of the following terms in relation to marginal costing.
4.
(a)
Break Even Point
(b)
Profit Volume Ratio
(c)
Margin of Safety
Explain what is meant by Break Even Analysis? Discuss (a)
The assumptions that are involved in this technique
(b)
The various uses of this technique.
5.
Explain any four circumstances in which the technique of marginal costing will help the
management in taking decisions. What are the limitations of this technique?
6.
The rate of earning profit mainly depends upon the magnitude of the angle of incidence
projected on break even chart.- Explain as to whether this statement is correct. What
measures can be adopted to increase the magnitude of angle of incidence.
7.
Write a critical note about uses, applications, advantages and limitations of Marginal
Costing technique.
8.
The work of separating the overheads into fixed and variable costs is purely academic,
but practically very difficult and as such the technique of Marginal Costing is of very little
use in managerial decisions. How will yon make out a case for introducing the technique
of Marginal Costing when encountered with the above argument?
9.
Discuss the most important areas of managerial decisions opened up by the application
of marginal costing technique.
10. Write Short Notes on (a)
Profit Volume Ratio-
(b)
Contribution
(c)
Break Even Point -
(d)
Margin of Safety -
(e)
Marginal Costing -
(f)
Importance of Break Even analysis -
Marginal Costing
405
PROBLEMS
(1)
Following information is made available to you about a company for two periods.
Period.
Sales (Rs)
Profit (Rs)
(I)
1,20,000
9,000
(II)
1,40,000
13,000
Find out
(2)
(a)
Profit Volume Ratio
(b)
Break Even Point for sales
(c)
Profit when sales are Rs. 1,00,000
(d)
Sales required to earn a profit of Rs. 20,000
(e)
Safety Margin in period II
The sales turnover and profits during two periods are as under.
Period I - Sales Rs. 20 Lakhs, Profit Rs. 2 Lakhs
Period II - Sales Rs. 30 Lakhs, Profit Rs. 4 Lakhs
Calculate:
(3)
(1)
P/V Ratio
(2)
The sales required to earn the profit of Rs. 5 Lakhs
Following figures relate to a company manufacturing a varied range of products :

Total Sales
Total Cost
Year ended 31st Dec., 1987
22,23,000
19,83,600
Year ended 31st Dec., 1988
24,51,000
21,43,200
Assuming stability in price with variable costs carefully controlled to reflect predetermined
relationship and an unvarying figure for fixed costs, calculate :
406
(a)
The profit volume ratio to reflect the rates of growth for profits and sales.
(b)
Fixed Costs.
(c)
Fixed Cost as % to Sales.
(d)
Break even point
(e)
Margin of safety for the year 1987 and year 1988.
(4)
Gee Ltd. has two factories producing an identical product and realising the same selling
price net i.e. Rs.60 per unit. The costs in the two factories can be summarised as
follows.
Factory A
Factory B
1,00,000
1,50,000
20
15
20,00,000
45,00,00
Capacity (Units) (Rs.)

Variable Cost per unit (Rs.)
Fixed Costs per annum (Rs.)
The demand for the product is 2,00,000 units. State how much should be produced at
each factory.
(5)
Calculate the Break Even Point in units and in rupees and also arrive at Margin of Safety
ratio from the following information.
Estimated sales (1,00,000 Units)
Variable Cost
Rs. 20,00,000
Rs. 12,00,000
Fixed Cost
Rs. 4,00,000
Rs.16,00,000
Net Profit
(6)
From the following data relating to a company, calculate :

(1)
Break Even Sales
(2)
Sales required to earn a profit of Rs.6,000 per period

Period
(7)
Rs. 4,00,000
(a)
Total Sales
Total Costs
Rs.
Rs.
42,500
38,700
39,200
36,852
A company budgets a production of 5,00,000 units at a variable cost of Rs. 20

each. The fixed costs are Rs. 20,00,000. The selling price is fixed to yield 25%
profit on cost.
Calculate (i)
(b)
Break Even Point
(ii) P/V Ratio
If the selling price is reduced by 20% find (i)
The effect of the price reduction on the break even point and the P/V Ratio
(ii)
The number of units required to be sold at the reduced selling price to obtain
an increase of 20% on the budgeted profit.
Marginal Costing
407
(8)
(1)
The following figures for profit and sales are obtained from the account of XYZ Co.
Ltd. Year
Sales (Rs.)
Profit (Rs.)
1985
20,000
2,000
1986
30,000
4,000
Calculate -
(2)
(9)
(a)
P/V Ratio
(b)
Fixed Cost
(c)
Break Even Sales
(d)
Sales to earn a profit of Rs. 5.000
Calculate all the above figures, if the company has a fixed overhead of Rs. 1,000 in
addition to the expenses considered above.
The following data are obtained from the records of a company.

First Year
Second Year
Rs.
Rs.
Sales
80,000
90,000
Profit
10,000
14,000
Calculate :
(a)
P/V Ratio
(b)
Break Even Point
(c)
Profit or loss when sales amount to Rs. 50,000
(d)
Sales required to earn a profit of Rs. 19,000
(e)
Sales position if company sustained a loss of Rs. 19,000
(10) The following figures relating to the performance of a company for Year I and Year II are
available. Assuming that the ratio of variable costs to sales and the fixed costs are the
same for both the years, ascertain a.
Profit Volume Ratio
b.
Amount of the fixed costs
c.
Break Even Point
d.
Budgeted profit for Year III if the budgeted sales are Rs. 1 Crore.
Year I
Year II
408
Total Sales
Rs. 70 Lakhs
Rs. 90 Lakhs
Total Costs
Rs. 58 Lakhs
Rs. 66 Lakhs
(11) S Ltd. furnishes you the following information relating to the half year ending 30th June
1980.
Rs.
Fixed Expenses
Sales Value
50,000
2,00,000
Profit
50,000
During the second half of the year, the company has projected a loss of Rs. 10,000.
Calculate (1)
The P/V Ratio, Break Even Point and Margin of safety for six months-ending 30th
June 1980.
(2)
Expected sales volume for the second half of the year assuming that selling price
and fixed expenses remain unchanged in the second half year also.
(3)
The break even point and margin of safety for the whole year 1980.
(12) PQ Limited has been offered a choice to buy a machine between A and B. You are
required to compute :
(a)
Break Even Point for each of the machines.
(b)
The level of sales at which both machines earn equal profits.
(c)
The range of sales at which one is more profitable than the others.
The relevant data is given below :

Machines
A
Annual output in units
10,000
10,000
Fixed Cost (Rs.)
30,000
16,000
Profit at above level of production (Rs.)
30,000
24,000
The market price of the product, is expected to be Rs.10 pet Unit

(13) The following is the basic cost of a firm ABC.
(1)
(i)
Fixed Operating Cost Rs. 2,500
(ii)
Sales Price (Per Unit) Rs. 10
(iii)
Variable Cost (Per Unit) Rs. 5

Determine BEP in units and rupees
Marginal Costing
409
(2)
If fixed operating cost increases to Rs. 3,000, what will be the new BEP ( in Units)?
(3)
If sale price increases to Rs. 12.50 and the variable operating cost to Rs.7.50, what
would be the impact on BEP?
(14) A Ltd. manufactures & sells four types of products under the brand names -P, Q, R and
S. Sales mix in value comprises. 33.33%, 41.66%,16.66% and 8.33% of P, Q, R and S
respectively. The total budgeted sales (100%) are Rs. 60,000 per month.
Operating Costs are Variable Costs
Product P -
60% of selling price
Product Q -
Product R -
Product S -
Fixed Costs : Rs. 14,700 per month

Calculate the BEP for the products on an overall basis i.e. in total
(15) Following information is presented by the costing department to the management
accountant of the company.
1.
Contribution Rs. 10,000
2.
Fixed Cost Rs. 5,000
3.
P/V Ratio 1/3
The Management Accountant is asked to find out the margin of safety if P/V Ratio is
brought down to 1/2.
(16) A company produces and sells 100 units of A at Rs. 20. Marginal cost per unit is Rs. 12
and the fixed costs are Rs. 300 per month. It is proposed to reduce the price by 20%.
Find out the additional sales required to earn the same amount of profits as before.
(17) A ball pen manufacturer has developed a new ball pen with unique features. His
development executive has suggested three possible retail price viz. Rs.15 for super
star, Rs.10 for deluxe and Rs. 7.50 for economy model. His marketing manager opines
that the whole sellers and retailers have to be given at least 30% discount.
The estimated fixed cost would be around Rs.70,000 and the variable cost per unit would
be Rs. 3.50
410
(a)
Calculate breakeven point for each model of ball pen.
(b)
How much should the manufacturer sell in order to make a profit of Rs. 21,000?
Work out for each model of ball pen.
(18) ABC Pvt. Ltd. manufactures and sells a standard product at fixed selling price. The
budgeted figures for 1986-87 are as under.
Production and sales
2,00,000 Units.
Variable cost
Rs. 56 Per Unit
Fixed Cost
Rs. 48,00,000
Profit Margin
33.33% of selling price.
You are required to determine sales at break even both in terms of quantity and value for
the budget year 1986-87 at the above selling price.
(19) The Laila Shoe Company sells five different styles of ladies chappals with identical purchase
cost and selling price. The company is trying to find out the profitability of opening
another store which will have the following expenses and revenues.
Per Pair (Rs)
Selling Price
30.00
Variable cost
19.50
Salesmens commission
1.50
Total Variable Cost
21.00
Annual Fixed expenses are :

Rent
Rs. 60,000
Salaries
Rs. 2,00,000
Advertising
Rs. 80,000
Other fixed expenses
Rs. 20,000
Rs. 3,60,000
Required :
a.
Calculate the annual break even point in units and in value. Also determine the
profit or loss if 35,000 pairs of chappals are sold.
b.
The sales commissions are proposed to be discontinued, but instead a fixed amount
of Rs. 90,000 is to be incurred in fixed salaries. A reduction in selling price of 5% is
also proposed. What will be the break even point in units ?
c.
It is proposed to pay the stores manager 50 paise per pair as further commission.
The selling price is also proposed to be increased by 5%. What would be the break
even point in units?
Marginal Costing
411
d.
Refer to the original data. If the stores manager were to be paid 30 paise commission
on each pair of chappal sold in excess of the break even point, what would be the
stores net profit if 50,000 pairs were sold ?
(20) Speedy Airline can carry a maximum of 10,000 passengers per month on one of its
routes at a fare of Rs. 85. Variable costs are Rs. 10 per passenger and fixed costs are
Rs. 3,00,000 p.m. calculate
(1)
Break Even quantity
(2)
Break Even sales
(3)
Break Even Percentage of capacity.
(4)
Suppose that the management sets a profit target of Rs. 2,00,000
What would be the required profit before taxes to achieve this profit target, if the corporate
tax rate of the company is 46%.
(21) Three firms X, Y and Z manufacture the same product. The selling price is Rs.8 per unit
of the product equal for all the firms. The fixed costs for the firms X, Y and Z respectively
are Rs. 80,000 Rs. 2,00,000 and Rs. 3,30,000 while the variable costs per unit are Rs. 6,
Rs. 4 and Rs. 3
(a)
Determine the break even point for all the firms in units.
(b)
How much profits are earned by the firms if each of them sells 80,000 units?
(c)
What will be the impact percentagewise .on profits if sales increase by 20%.
(22) Merry Manufacturers Ltd. has supplied you the following information in respect of one of
its products.
Rs.
Total Fixed costs
18,000
Total Variable Costs
30,000
Total Sales
60,000
Units Sold
20,000
Find out (a) Contribution per unit (b) Break Even Point (c) Margin of Safety (d) Profit (e)
Volume of sales to earn a profit of Rs. 24,000.
412
(23) From the following information relating to Quick Standards Ltd., you are required to find
out - (a) Contribution (b) BEP in units (c) Margin of Safety (d) Profits.
Rs.
Total fixed costs
4,500
Total variable costs
7,500
Total sales
15,000
Units sold
5,000 (Units)
Also calculate the volume of sales to earn a profit of Rs. 6,000

(24) Bindra Ltd. is running its plant at present at 50% of capacity. The management has
supplied you the following details.
Cost of production per unit
Rs.
Direct Material
Direct Labour
Variable Overheads
Fixed Overheads (fully absorbed)
4
16
Production per month
40,000 Units
Total cost of products
40,000 Units x Rs. 16 = Rs. 6,40,000
Sales Price
40,000 Units x Rs. 14 = Rs. 5,60,000

Loss
Rs. 80,000
An exporter offers to purchase 10,000 units per month @ Rs. 13 per unit and the company
is hesitating in accepting the offer due to the fear that it will increase its already large
operating losses.
Advice whether the company should accept or decline this offer.
(25) Mega Corporation manufactures and sells three products to the automobile industry. All
the products must pass through a machining process, the capacity of which is limited to
20,000 hours per annum, both by equipment design and government regulation.
Marginal Costing
413
Following additional information is available.

Product X
Product Y
Product Z
Selling Price Rs./Unit
1,900
2,400
4,000
Variable cost Rs./Unit
700
1,200
2,800
10,000
2,000
1,000
Machining requirements hrs/Unit

Maximum possible sales units
Required - A statement showing the best possible production mix which would provide
the maximum profits for Mega Corporation, together with supporting workings.
(26) (a)
(b)
A companys turnover in a year was Rs. 50,00,000, its profit was Rs. 500,000 and
its P/V Ratio was 40% What is the break even point?
A factory furnishes the following figures.
August 84
September 84
50,000
55,000
6,70,000
7,10,000
Output (Units)
Total Cost (Rs.)
What is the amount of fixed expenses per month?

(27) (a)
(b)
Calculate the Break Even Point from the following data.

(i)
Sales Price per unit Rs. 10
(ii)
Variable cost per unit Rs. 6
(iii)
Fixed overheads Rs.20,000
Calculate the revised Break Even Point if (i)
Sales price is increased to R.11 per unit
(ii)
Sales price is reduced to Rs.9 per unit
(iii)
Variable cost increased to Rs.7 per unit
(iv)
Variable cost reduced to Rs.5 per unit
(v)
Fixed overheads rise to Rs.25,000
(vi)
Fixed overheads fall to Rs.15,000
(28) The Modern Machine Co. Ltd. places before yon the following figures
414
Sales (Rs.)
Profit (Rs.)
1974
2,00,000
10,000
1975
1,80,000
2,000
Calculate profit or loss when sales amount to Rs. 1,50,000 and Rs-3,00,000.
(b)
Calculate Profit Volume Ratio.
(c)
Determine sales at Break Even Point.
(29) The selling price of a product is Rs.40 which yields a margin of 20%. The total fixed
expenditure are Rs. 10,000 a month. What should be the level of sales to yield an annual
profit of Rs.20,000?
(30) The following is the annual profit plan of XYZ Company.
(1)
(2)
Budgeted sales
(2,00,000) units @ Rs. 25)
Budgeted Costs
Direct Material
Direct Labour
Factory Overheads
Distribution Expenses
50,00,000
Fixed
Variable
7,00,000
6,00,000
5,00,000
9,00,000
10,00,000
3,00,000
1,00,000
3,00,000
18,00,000
26,00,000
Budgeted Profit
44,00,000
6,00,000
Production capacity - 2,40,000 Units.

(A) (a)
Determine the break even point in rupees.
(b)
Would you accept an export order for 60,000 units @ Rs. 20 per unit and
why?
(c)
Briefly enumrate the basic assumptions underlying break even analysis.
(B) Compute BEP in the following independent situations if (i)
a 10% increase is effected in fixed costs
(ii)
a 10% increase is effected in variable costs
(iii)
a 10% increase in fixed costs and 5% decrease in-variable costs is effected.
(31) You are the company Accountant of Machine Manufacturing Ltd. which was incorporated
in February 1979. The company has started production from 1st January 1980.
It was proposed that the company will produce and sell 8,000 units in the first year of its
operations. Estimated costs of production are given below.
Marginal Costing
415
Raw Materials
Rs. 20 per unit
Direct Labour
Rs. 10 per unit
Other variable costs
200% of direct labour
Fixed costs
Rs.1,50,000
(1)
The company fixed a target to earn a profit of Rs. 1,50,000 in the first year.
(2)
Further, the company expects that annual fixed costs will increase by Rs. 1,00,000
in the second year of operations. The marketing manager has planned to spend a
sum of Rs. 80,000 on promotion and advertising in the second year, keeping in view
the target of the company to earn a profit of Rs. 2,50,000 in the second year of
operations. It is expected that direct material, direct labour and other variable costs
will not change in the second year.
(3)
The company wishes to sell the product in the second year at a price of Rs.75 per
unit.
Advice the company about the following :

(a)
Selling price for the first year.
(b)
Sales turnover ( in Units) for the second year.
(32) The Asian Industries specialise in the manufacture of small capacity of Motors. The cost
structure of a motor is as under.
Material
Rs. 50
Labour
Rs. 80
Variable Overheads 75% of labour cost.

Fixed overheads of the company amount to Rs. 2.40 lakhs per annum.
The sale price of the motor is Rs. 230 each.
(a)
Determine the number of motors that have to be manufactured and sold in a year to
break even.
(b)
How many motors have to be made and sold to make a profit of Rs.1 lakh per year?
(c)
If the sale price is reduced by Rs. 15, how many motors will have to be sold to
break even?
(33) Repographics Ltd. manufactures a document reproducing machine which has the variable
cost structure as follows :
Material
Rs. 40
Labour
Rs. 10
Overheads
Rs. 4
Selling price per unit is Rs. 90
416
Sales during the current year are expected to be Rs. 13,50,000 and fixed overheads
Rs. 1,40,000.
Under a wage agreement, an increase of 10% is payable to all direct workers from the
beginning of the forthcoming year, whilst material costs are expected to increase by
7.5%, variable overheads by 5% and fixed overhead costs by 3%.
You are required to calculate :
a.
The new selling price if the current Profit Volume Ratio is to be maintained.
b.
The quantity to be sold during the forthcoming year to yield the same amount of
profit as the current year, assuming the selling price to remain at Rs. 90.
(34) Cookwell Ltd.manufactures pressure cookers the selling price of which is Rs. 300 per
unit. Currently the capacity utilisation is 60% with a sales turnover of Rs. 18 lakhs. The
company proposes to reduce the selling price by 20% but desires to maintain the same
profit position by increasing the output. Assuming that the increased output could be
made and sold, determine the level at which the company should operate, to achieve the
desired objective.
The following further data are available.
(a)
Variable cost per unit Rs.60
(b)
Semi variable cost (including a variable element of R1. 10 per unit) Rs. 1,80,000
(c)
Fixed cost Rs. 3,00,000 will remain constant Upto 80% level. Beyond this, an
additional of Rs. 60,000 will be incurred.
(35) The MYZ Co. has the following budget for the year 1986-87.
Rs.
Sales (1,00,000 Units a Rs.20)
20,00,000
Variable Cost
10.00,000
Contribution
10,00,000
Fixed cost
4,00,000
Net Profit
6,00,000
From the above set of information find out,

(a)
The adjusted profits for 1986-87 if the following two sets of changes are introduced
and also suggest which plan should be implemented.
Marginal Costing
417
Plan A
Increase in Price
20%
Decrease in Price
20%
Decrease in Volume
25%
Increase in Volume
25%
Increase in variable cost
10%
Decrease in Variable cost
10%
Increase in fixed cost

(b)
Plan B
5%
Decrease in fixed cost
5%
The P/V Ratio and break even points under the two plans referred above.
(36) A review made by the top management of Sweat and Struggle Ltd. which makes only
one product, of the result of the first quarter of the year revealed the following details :
Sales in units
10,000
Loss in Rs.
10,000
Fixed Cost (For the year Rs.1,20,000) in Rs. 30,000

Variable cost per unit in Rs.
The Finance Manager who feels perturbed suggests that the company should at least
break even in the second quarter with a drive for increased sales. Towards this, the
company should introduce a better packing which will increase the cost by Re. 0.50 per
unit.
The sales manager has an alternative proposal. For the second quarter, additional sales
promotion expenses can be increased to the extent of Rs. 5,000 and a profit of Rs. 5,000
can be aimed with increased sales.
The production manager feels otherwise. To improve the demand, the selling price per
unit has to be reduced by 3%. As a result, the sales volume can be increased to attain
a profit level of Rs. 4,000 for the quarter.
The Managing Director asks you as a Cost Accountant to evaluate these three proposals
and calculate the additional sales volume that would be required in each case, in order to
help him take a decision.
(37) Following is the summarised Trading account of a manufacturing concern which makes
two products X and Y.
418
Summarised Trading Account for the four months to 30th April 1984
X
Rs.
Y
Rs.
Total
Rs.
10,000
4,000
14,000
4,500
2,000
6,500
5,500
2,000
7,500
2,000
1,000
3,000
3,500
1,000
4,500
X and Y
1,250
1,250
2,500
Net Profit
2,250
(-)250
2,000
Sales
Less : Cost of Sales
(a)
Direct costs
Labour
3,000
1,000
Material
1,500
1,000
Indirect costs
(a)
(b)
Variable Expenses
Fixed Expenses
Common to both
(a)
These costs tend to vary in direct proportion to physical output.
(b)
These costs tend to remain constant irrespective of physical outputs of X and Y.

It has been the practice of the concern to allocate these costs equally between
X and Y.
The following proposals have been made by the Board of Directors for your consideration
as financial advisor.
(1)
Discontinue Product Y.
(2)
As an alternative to (1), reduce the price of Y by 20%. (It is estimated that the
demand then will increase by 40%.)
(3)
Double the price of X (It is estimated that the demand then will reduce by three
fifths.)
You are required to recommend the proposal to be taken after evaluating each of
these three proposals.
Marginal Costing
419
(38) A Multi-Product company has the following costs and output data for the last year.
Sales Mix (in value)

Product X
Product Y
Product Z
40%
35%
25%
Rs. 20
Rs. 25
Rs. 30
Rs. 10
Rs. 15
Rs. 18
Total Fixed cost
Rs. 1,50,000
Total Sales
Rs. 5,00,000
The company proposes to replace Product Z by Product S. Estimated cost and output
data are Product X
Product Y
Product S
50%
30%
20%
Rs. 20
Rs. 25
Rs. 28
Rs.10
Rs. 15
Rs. 14
Sales Mix (in value)
Total fixed cost
Rs. 1,50,000
Total Sales
Rs. 5,00,000
Analyse the proposed change and suggest what decision the company should take.
Also state the break even point for the company as a whole in the two situations.
(39) A manufacturer has planned his level of production at 50% of his plant capacity of 30,000
units. At 50% of the capacity, his expenses are as follows.
(a)
Direct Labour Rs.11,160
(b)
Direct Material Rs. 8,280
(c)
Variable and other manufacturing expenses Rs. 3,960
(d)
Total fixed expenses regardless production Rs. 6,000
The home selling price is Rs.2.00 per unit. Now, the manufacturer receives a trade
enquiry from overseas for 6,000 units at a price of Rs. 1.45 per unit If you were the
manufacturer, would yon accept or reject the offer? Support your statement with suitable
cost and profit details.
(40) A manufacturer sells his product at Rs.5 each variable costs are Rs.2 per unit and the
fixed costs amount to Rs.60,000.
420
(a)
Calculate the break even point
(b)
What would be the profit if he sells 30,000 units?
(c)
What would be the BEP if he spends Rs.3,000 on advertisement?
(d)
How much should the manufacturer sell to make a profit of Rs.30,000 assuming he
spends Rs.3,000 on advertisement?
(41) Texemat Private Limited has been manufacturing track suits for athletes currently, its
output is around 70% of its rated capacity of 19,000 units per annum. One exporter has
approved the sample and has offered to buy 5000 units at a special price of Rs. 150 per
suit. At present, the company has been selling the track suit @ Rs.210.The standard
cost per unit is as under. .
Cost Items
Rs.
(a)
Cloth and other materials
82
(b)
Labour
25
(c)
Fixed cost
42
(d)
Administrative variable cost
11
Total Cost
160
(a)
Should the company accept the offer?
(b)
What would be your advice if the exporter offers to buy 10,000 units instead of 5000
units?
(42) The variable cost structure of a product manufactured by a company during the current
year is as under Rs.
Per Unit
Material
120
Labour
30
0verheads
12
The selling price per unit is Rs. 270 and the fixed cost and sales during the current year
are Rs. 14 Lakhs and Rs. 40.50 Lakhs respectively.
During the forthcoming year, the direct workers will be entitled to a wage increase of 10%
from the beginning of the year and the materials cost, variable overhead and fixed overhead
are expected to increase by 7.5%, 5% and 3% respectively.
The following are required to be computed a.
New selling price in the forthcoming year if the current P/V ratio is to be maintained.
b.
Number of units that would be required to be sold during the forthcoming year so as
to yield the same amount of profit in the current year, assuming that the selling
price per unit will not be increased.
Marginal Costing
421
(43) A company currently operating at 80% capacity has the following particulars.
Rs.
Sales
32,00,000
Direct Materials
10,00,000
Direct Labour
4,00,000
Variable Overheads
2,00,000
Fixed Overheads
13,00,000
An export order has been received that would utilise half the capacity of the factory. The
order cannot be split i.e. it has either to be taken in full and executed at 10% below the
normal domestic prices or rejected totally.
The alternatives available to the management are :
a.
Reject the order and continue with the domestic sales only (as at present) or
b.
Accept the order, split capacity between overseas and domestic sales and turn
away excess domestic demand or
c.
Increase capacity so as to accept the export order and maintain the present domestic
sales by i)
buying an equipment that will increase the capacity by 10%. This will result in
an increase of Rs. 1,00,000 in fixed costs and
ii)
work overtime to meet the balance of required capacity. In that case, labour
will be paid at one and half times the normal wage rate.
Prepare a comparative statement of profitability and sugget the best alternative.

(44) A company produces a single product which is sold by it presently in the domestic
market at Rs. 75 per unit. The present production and sales is 40,000 units per month
representing 50% of the capacity available. The cost data of the product was as under Variable cost per unit Rs. 50
Fixed costs per month Rs. 10 Lakhs
To improve the profitability, the management has 3 proposals on hand as under -
422
a.
to accept an export supply order for 30,000 units per month at a reduced price of
Rs. 60 per month, incurring additional variable costs of Rs. 5 per unit towards the
export packing, duties etc.
b.
to increase the domestic market sales by selling to a domestic chain stores 30,000
units at Rs. 55 per unit retaining the existing sales at existing price
c.
to reduce the selling price for the increased domestic sales as advised by the sales
department as under
Reduce selling price per unit by Rs.
Increase in sales expected (units)
10,000
30,000
11
35,000
Prepare a table to present the results of the above proposals and give your comments
and advice on the proposals.
(45) A company producing a single product sells it at Rs. 50 per unit. Unit variable cost is
Rs. 35 and fixed cost amounts to Rs. 12 Lakhs per annum. With this data, you are
required to calculate the following, treating each independent of the other a.
P/V Ratio and the Break Even Point
b.
New Break Even Sales if variable cort increase by Rs. 3 per unit, without increase
in the selling price.
c.
Increase in sales required if profits are to be increased by Rs. 2.40 lakhs
d.
Percentage increase/decrease in sales volume to offset
e.
An increase of Rs. 3 in the variable cost per unit
A 10% increase in selling price without affecting existing profits quantum
Quantum of advertisement expenditure permissible to increase sales by Rs. 1.20

Lakhs without affecting profits quantum.
(46) A manufacturer of fountain pens selling in the market at Rs.100 per dozen makes an
average net profit of 20% on sales by producing 50,000 dozen per annum against a
capacity of 75,000 dozens. His cost sheet for 1984 was as under.
Cost per dozen in Rs.
Direct Materials
36
Direct Wages
30
Works overheads
(50% of this is variable)
10
Sales overheads
(25% of this is variable)
In 1985, he anticipates his fixed costs to increase by 6%, cost of direct materials by 5%,
and labour (with whom an agreement has been concluded) by 10%. Market enquiries
revealed that the selling price of the product and quantity will remain unchanged in 1985.
Marginal Costing
423
An inquiry has been received for the supply of 10,000 dozens to a customer. What could
be the lowest quotation, if the business wants to make a minimum profit of Rs. 8 lakhs
in 1985? Give detailed workings.
(47) The following figures relate to the current years position in an engineering industry operating
at 70% capacity level.
Break Even Point
Rs.80 Crores
P/V Ratio
40%
Margin of Safety
Rs 20 crores
The board at its last meeting have taken a decision to increase the output to 98%
capacity level with the following modifications.
(i)
Reduction in selling price by 5%
(ii)
Increase in fixed cost by Rs.8 crores (Including depreciation on additions but

excluding interest burden.).
(iii) Reduction in variable cost by 5% of sales.

(iv)
Additional finance for capital expenditure and working capital Rs.20 crores.
(a)
You are required to determine the revised sales figure necessary to yield the
existing quantum of profits plus additional profit of Rs.4 crores on account of
increased activity and 20% Interest burden on fresh capital inputs.
(b)
Also determine the revised (i)
Break Even point
(ii)
P/V Ratio
(iii) Margin of safety.

(48) The following data are obtained from the records of a factoryRs.
Sales 4,000 Units @ Rs.25 each
Rs.
1,00,000
Materials consumed
40,000
Variable Overheads
10,000
Labour overheads
20,000
Fixed overheads
18,000
88,000
Net Profit
424
12,000
Calculate :
(1)
The number of units by selling which the company will neither loose or gain anything.
(2)
P/V Ratio and Margin of Safety at present level.
(3)
The extra units which should be sold to obtain the present profit if it is proposed to
reduce the selling price by (a) 20% and (b) 25%.
(4)
The selling to be fixed price to bring down its break even point to 500 units under
present condition.
(5)
The sales required to earn profit of Rs.60,000 at the present selling price of Rs.25
per unit,
(49) You are given the following data pertaining to a factory.

Present (1986)
Forecast (1987)
Sales (in Units)
10,000
15,000
Fixed cost (in Rs.)
25,000
25,000
Loss (in Rs.)
5,000
Profit (in Rs.)
5,000
For the above working purposes, variable cost of sales has been taken at Rs.7 per unit
upto 15000 units and it shall be Rs.8 per unit beyond 15,000 units.
You are required to state as to
(1)
What percentage of increase in sales is required to cover additional 50 paise per

unit towards extra packing cost in 1987 for achieving the additional sales target?
(2)
What percentage of increase in sales is required to maintain budgeted profit with a

price reduction of 25 paise per unit?
(3)
What percentage of increase in sales is required to meet additional publicity

expenses of Rs. 2,000 and also maintain the targeted profits?
(4)
What is the maximum increase in fixed cost (additional depreciation) per period to
justify the proposal for buying a new machine which will reduce variable cost of
sales by Rs. 2 per unit at all levels? Sales to remain at 10,000 units and the
targeted profit to be achieved.
(The above situations have to be considered independently of each other.)
(50) The anticipated sales of Electronic Corporation Ltd. is Rs. 4,00,000 and unit sales price
of product is Rs.20 each. The cost of direct material is Rs.9 each and the labour cost is
Rs.3 each and other variable expenses are Rs.3 per unit. The company is earning a net
profit of 5% and to improve the profitability, following propositions were discussed in the
Executive Committee Meeting,
Marginal Costing
425
(a)
The present administration set up is on the regional basis and it was felt that
centralisation will reduce the fixed cost by Rs. 12,000.
(b)
The production manager has agreed that he will try to Work on a cost reduction
programme which will reduce the cost by Re.1 per unit but there will be little impact
on the quality which will be negligible to the customer.
The sales manager opposed the two proposals and suggests that it may be possible to
increase the number of units sold by 20% provided the selling price is reduced by 5%.
Alternatively, if the selling price is increased by 10%, the sales number of units will be
reduced by 5%.
As the Accountant of the company, discuss in detail the various pros and cons of the
proposals and also put forward any other proposal to improve the situation.
(51) Zed Ltd. reported the following figures for 1983 and 1984.
1983
1984
Sales
Rs. 50,00,000
Rs. 60,00,000
Total Cost
Rs. 45,00,000
Rs. 52,00,000
The company anticipated that in 1985.

(i)
Variable cost rates, on the average, would record an increase of 10% over the 1984
levels.
(ii)
Sales would record an increase of 20% over the 1984 level in volume.
(iii) Selling prices on the average would be increased by 5%.

(iv)
In addition, another Rs.10 Lakhs of sale (1984 level) would be made to Government
at a special discount of 10% thereof.
(v)
Fixed costs would increase by Rs. 3,00,000.
Ascertain the expected profit/loss in 1985. If the increase in fixed costs mentioned
above arises only if sales to Government is made, would you recommend the sale to be
made? What is the P/V Ratio for 1985, at normal sales? Give workings.
(52) Two business AB Ltd. and CD Ltd. sell same type of product in the same type of market.
Their budgeted profit and loss account for the year 1984 is as follows :
426
AB Ltd.
Rs.
Sales
CD Ltd.
Rs.
Rs.
1,50,000
Cost Fixed
Variable
1,50,000
15,000
35,000
1,20,000
1,00,000
Net Profit
Rs.
1,35,000
1,35,000
15,000
15,000
Calculate the Break Even Point of each business.
(b)
State winch business is likely to earn greater profits in condition of(i)
Heavy demand for the product
(ii)
Low demand for the product
(53) In a factory producing two different kinds of articles, key factor is the availability of labour.
From the following information for the factory for 1986. show which product is more
profitable.
Product A
cost per
Unit Rs.
Product B
Cost per
Unit Rs.
5.00
5.00
6 hrs @ Rs. 0.50
3.00
3 hrs @ Rs. 0.50
1.50
- Fixed (50% of labour)
1.50
0.75
- Variable
1.50
1.50
11.00
8.75
14.00
11.00
3.00
2.25
500
600
Material
Labour
Overheads
Selling Price
Profit
Total Production per month (Units)
Maximum capacity per month
4,800 hours
Maximum capacity of product B
1,000 Units
Marginal Costing
427
(54) (a)
The following particulars are extracted from the records of a company.

Product A
per Unit
Product B
per Unit
Rs. 1.00
Rs. 1.20
2 kgs
3 kgs.
Material Cost
Rs. 10
Rs. 15
Direct Wages Cost
Rs. 15
Rs. 10
Rs. 5
Rs. 6
Rs. 5
Rs. 10
Rs. 15
Rs. 20
Sales
Consumption of material
Direct Expenses
Machine hours used 3 : 2
Overhead Expenses
Fixed
Variable
Direct Wages per hour is Rs.5. Comment on profitability of each product (both use the
same raw material) When (i)
Total Sales Potential is limited.
(ii)
Raw Material is in short supply.
(iii) Production capacity ( in terms of machine hours) is the limiting factor.

(b)
Assuming raw material is the key factor, availability of which is 10,000 kgs. and
maximum sales potential of each product being 3,500 units, find out the product
mix which will yield the maximum profit.
(55) The following particulars are available from a manufacturing unit

A
80,000
80,000
2,00,000
Sales
Rs. 40,000
Rs. 80,000
Rs. 50,000
Material Cost
Rs. 20,000
Rs. 30,000
Rs. 25,000
Labour Cost
Rs. 6,000
Rs. 10,000
Rs. 8,000
Variable Expenses
Rs. 4,000
Rs. 4,000
Rs. 5,000
Fixed overheads.
Rs. 7,000
Rs. 10,000
Rs. 5,000
Units Sold
The key factor of production is an imported raw material and the consumption of the
material in product A is 400 litres. Product B is 1,000 litres and Product C is 600 litres.
The sales manager gives an assurance that it is possible for him to sell whatever produced.
The management of the company has decided to close down one product line and
428
concentrate on two lines to increase the profitability of the company. As the company
Accountant, prepare a report to the Directors recommending the closure of one of the
lines which is not more profitable.
(56) Ambika Condiments bring out 2 products SUCHI and RUCHI which are popular in the
market. The management has the option to alter the sales mix of the 2 products from the
following combinations Option
SUCHI (units)
RUCHI (units)
800
600
II
1,600
III
1,300
IV
1,100
500
The per unit production cost/sales data are

SUCHI (units)
RUCHI (units)
Direct Materials (Rs.)
25
30
Direct Labour (hours)
10
12
Selling Price (Rs.)
75
90
Variable factory overheads are 100% of direct labour cost for both products.
Labour rate is Rs. 2 per hour.
Common fixed overheads for both products Rs. 10,000.
Prepare a marginal cost statement for the two products.
b.
Evaluate options and identify the most profitable sales mix.
(57) From the following particulars, find the most profitable product mix and prepare a statement
of profitability of that product mix.
Product A
Product B
Product C
1,800
3,000
1,200
60
55
50
Direct Materials (Kgs)
Direct Labour (Hours)
Variable Overheads (Rs.)
13
10
10
10
4,000
5,000
1,500
Units budgeted to be produced and sold

Selling Price per unit (Rs.)
Requirement per unit :
Fixed Overheads (Rs.)

Maximum possible units of sales
Marginal Costing
429
Cost of material per Kg is Rs. 4 and labour hour rate is Rs. 2. All the three products are
produced from the same direct material using the same types of machines and labour.
Direct labour which is the key factor is limited to 18,600 hours.
(58) The Skyrock Ltd. produces and sells three types of products P, Q, and R. The
management committee has decided to discontinue the production of Q since there is
not much profit in it. From the following set of information, find out the profitability of the
products and give your short comments on the decision of the management.
Product
Selling
Price
Per unit
Rs.
Direct
Material
Per unit
Rs.
Direct Wages
Per unit
Dept. A
Dept. B
Rs.
Rs.
300
60
20
15
10
275
30
20
20
10
305
70
12
10
20
Dept. C
Rs.
The absorption rate of overheads on the Direct Wages are

Dept. A
Dept. B
Dept. C
Variable Overheads
150%
120%
200%
Fixed overheads
200%
240%
150%
(59) You had asked your accountant to prepare fair budgets based on different economic
forecasts. After doing part A the work, he fell sick. Incomplete workings done by him
were as under.
Economic Forecast
Depressed
Average
Good
Excellent
40
60
90
140
Variable Cost (Rs. 000)
There are fixed costs of Rs.72,000 and P/V Ratio is 60%. Calculate.
(a)
The profit or loss at each of the four levels.
(b)
The break even point in sales value and
(c)
The sales value at which a profit of Rs .15000 would be made.
(60) Following is the abridged Profit and Loss Account of W Ltd. for 1987
(Rs. in Lakhs)
Sales (10 Lakhs Units @ Rs. 2.50 Per unit)
25.00
Less :
16.00
Less :
Variable Cost
Contribution
9.00
Fixed Costs
9.20
Loss:
430
(-) 0.20
S. Ltd. approaches W Ltd. which has spare capacity and offers to purchase 2 lakh units
from W Ltd. If W Ltd. accepts this offer, it will save Rs. 0.25 per unit in sales commission.
Existing scales will continue as above. What is the price per unit on this special offer
that W Ltd. must charge in order that an Overall profit of Rs. 50,000 can be earned on
total sales.
(61) The profit of a company works out to 12.5% on capital employed in 1986. The details are
as follows.
Rs. 000s
Sales
500
Direct Material
250
Direct Labour
100
Variable overheads
40
Capital Employed
400
(a)
Forecast for 1987 indicates sales will increase by 10%, selling price will go up by
4% and cost elements will go down by 2%. Assuming no change in the capital
employed, calculate the return on capital employed.
(b)
The new sales manager who has joined the company recently estimates for the
next year a profit of about 23% on capital employed, provided the volume of sales is
increased by 10% and simultaneously there is an increase in selling price of 4%
and an overall cost reduction in all elements of cost by 2%.
Find out by computing in details the cost and profit for the next year. Whether the
proposal of sales manager can be adopted?
(62) A multi product company has the following costs and output data for the last year.
X
Sales Mix
Products
Y
40%
35%
25%
Selling Price
Rs. 20
25
30
Rs. 10
15
18
Total Fixed cost Rs. 1,50,000

Total Sales Rs. 5,00,000
The company proposes to replace Product Z by product S. Estimated cost and output
data are :
Marginal Costing
431
X
Sales Mix
Products
Y
50%
30%
20%
Selling Price
Rs. 20
25
28
Rs. 10
15
14
Total Fixed cost Rs 1,50,000

Total Sales Rs. 5,00,000
Analyse the proposed change and suggest what decision the company should take.
(63) The following set of information is presented to you by your client AB Ltd.
(1)
Direct Materials ( per unit ) X-Rs. 20 Y- Rs.l8.
(2)
Direct Wages (per unit) X - Rs.6 Y- Rs. 4
(3)
Fixed expenses during the period are expected to be Rs. 1,600
(4)
Variable expenses are allocated to products @ 100% of Direct Wages.
(5)
Sales Price (Per Unit) X - Rs.40 Y- Rs.30
(6)
Proposed Sales mixes (i)
100 Units of X and 200 units of Y
(ii)
150 Units of X and 150 Units of Y
(iii)
200 Units of X and 100 Units of Y
As a Cost Accountant, you are requested to present to the management of AB Ltd. the
following.
(a)
The unit marginal cost and unit contribution.
(b)
The total contribution and resultant profit from each of the above sales mixes,
(c)
The proposed sales mixes to earn a profit of Rs.300 and Rs.600 with the total sales
of X and Y being 300 units.
(64) An enthusiastic marketing manager suggests to his managing director that if only he is
permitted to reduce the selling price of a product by 20%, he would be able to achieve a
30% increase in sales volume. The Managing Director, finding that the sales volume
exceeds in percentage the extent of required reduction in price, gives the clearance. You
are given the following information.
Present selling price per unit
Present volume of sales
2,00,000 Nos.
Total variable costs
Rs. 10,50,000
Total fixed costs
432
Rs. 7.50
Rs. 3,60,000
Assuming no changes in the cost in the continuing period,

(i)
Examine the consequences of the Managing Directors decision assuming that

30% increase in sales is realised.
(ii)
At what volume of sales can the present quantum of profits be achieved after effecting
the price reduction.
(65) SV Ltd. has budgeted the manufacture of 30,000 units of its only product A for the next
quarter.
The capacity of the factory has not been fully utilised.
The variable cost per unit of product A is as under :
Rs.
Direct Material
48.00
Direct Wages (Rs.4 per hour)
36.80
Factory variable overheads

Selling variable overheads
27.60
18.00
Product A is sold at Rs.200 per unit. Fixed overheads for the quarter are Rs. 15,00,000.
At present, the company manufactures component P one unit of which is used in each
unit of Product A. The cost of this component is already included in the cost structure
of Product A as aforesaid. Anyhow, the cost per batch of 1000 units of component P is
separately supplied as under.
Rs.
Direct Material
Direct Wages
6,000
4,800
Factory variable overheads
3,600
Fixed overheads apportioned to the component
3,600
18,000
It is proposed to utilise the spare capacity by manufacture of 1,500 units of product B

for export. The details are as under :
Export selling price
Rs. 228 per unit
Rs. 80 per unit
Direct labour
16 hours per unit
Variable expenses applicable to this product - Rs. 20 per unit.

Factory variable overheads have to be charged, calculated on the basis of Direct Labour
Hour Rate applicable to Product A.
It has to be noted that component P is not used in the manufacture of product B.
Marginal Costing
433
You are required to (i)
Present a statement showing the profit as originally envisaged in the budget.
(ii)
State whether component P should be manufactured or bought from the market if

this can be procured at a price of Rs. 16 per unit.
(iii) Calculate the contribution on account of accepting the export order of product B.
(66) A small scale manufacturer produces an article at the operated capacity of 10,000 units
while the normal capacity of his plant is 14,000 units. Working at a profit margin of 20%
on sales realisation, he has formulated his Budget as under 10,000
14,000
Rs.
Rs.
2,00,000
50,000
2,80,000
70,000
Semi- Variable overheads
20,000
22,000
Fixed overheads
40,000
40,000
Sales Realisation
Variable overheads
He gets an order for a quantity equivalent to 20% of the operated capacity and even on
this additional production, profit margin is desired at the same percentage on sales
realisation as for production to operated capacity.
Assuming prime cost is constant per unit of production, what should be the minimum
price to realise this objective?
(67) The executives of B Co., a small manufacturer of one product are developing the annual
profit plan. They have just reviewed the First Cut at the annual income statement and
are concerned with the Rs. 1,10,000 indicated profit on a sales volume of 20,000 units.
The fixed cost structure of Rs.9,90,000 appears to be high and they have some doubts
about departing from the unit sale price of Rs.100. There is a general agreement that the
Profit target should be Rs. 2,20,000. This case deals with several tentative alternatives
suggested during the meeting of the executives committee that just reviewed the tentative
profit plan.
You are required to compute (a)
The budgeted break even point in rupees and in units and the number of units that
would have to be sold to earn the target profit?
(b)
You are also required to respond directly to each of the following two alternatives
under consideration by the management. Consider each independent of the other
and state any assumptions that you would like to make.
Alternative 1 - A sale price increase of 15% is contemplated, the sales executive

estimates that this will cause a drop in units that can be sold by 15%. What would be
the new breakeven point in Rs. and in units? What would be the new profit figure?
How many units would have to be sold to earn the target profit?
434
Alternative 2 - A decrease in fixed costs of Rs-55,000 and a decrease of variable costs

of 6% are contemplated. What would be the new BEP in Rs. How many units must be
sold to earn the target profit.
(68) Stoner company uses three different components (Materials) in manufacturing its primary
product. Stoner manufactures two of the components and purchases one (designated
as component 1) from outside suppliers. The company is currently developing the annual
profit plan. Sales are highly seasonal, component 2 cannot be acquired from outsiders,
however component 3 can be purchased. The three components have critical
specifications. The annual profit plan provided data for the following computations.
Component 3 Unit Cost
(at 12,000 units)
Rs.
Material (Direct)
1.40
Labour (Direct)
2.20
Fixed overheads (apportioned)
0.40
Annual machine rental

(Special machine used only for component 3)
0.50
Variable factory overhead
1.00
Average storage cost per year (fixed)
0.40
Total
5.90
Average inventory level 500 units.

The Purchase Manager investigated outside suppliers and found one that would sign a
one year contract to deliver 12,000 quality units as needed during the year at Rs.5.20
per unit. Serious consideration is being given to this alternative. Should Stoner make or
buy component 3? Explain the relevant factors influencing your decision.
(69) From the following data, which product would you recommend to be manufactured in the
factory when(1) Time is the key factor.
(2)
Raw material is in short supply.
(3)
Sales potential in units is a limiting factor.
(4)
Sales potential in value is a limiting factor.
Direct Material
(Rs. 2 per Kg.)
Direct Labour
(Rs. 1 per Hour)
Variable Overheads
Selling Price
Marginal Costing
Per unit of Product A

Rs.
Per unit of Product B

Rs.
24
14
2
4
100
3
6
110
435
NOTES
436
Chapter 12
BUDGETARY
CONTROL
INTRODUCTION :
Budget and Budgetary control :
The term Budget is defined as a financial and/or quantitative statement, prepared prior to a
defined period of time, of the policy to be pursued during that period for the purpose of attaining
a given objective.
The analysis of this definition reveals the following characteristics of the budget.
(1)
It may be prepared in terms of quantity or money or both.
(2)
It is prepared for a fixed or set period of time.
(3)
It is prepared before the defined period of time commences.
(4)
It spells out the objects to be attained and the policies to be pursued to achieve that
objective.
The term Budgetary Control is defined as the establishment of budgets, relating the
responsibilities of executives to the requirements of a policy and the continuous comparison
of actual with budgeted results, either to secure by individual action the objective of that policy
or to provide the basis for its revision.
The analysis of this definition reveals the following facts about budgetary control.
(1)
It deals with the establishment of the budgets..
(2)
It deals with the comparison of budgeted results with the actual results.
(3)
It deals with computation of the variations and the actions to be taken for maintaining the
favourable variations, removing the adverse variation or revising the Budgets themselves.
Budgetary Control
437
ADVANTAGES OF BUDGETARY CONTROL :

(1)
It is a powerful tool available to the management for the purpose of cost control and
maximization of profits through the same. It enables the management to utilize the
available resources in the most profitable manner.
(2)
A budget sets the plan of action. Plans in respect of various functional areas of operations
are expressed in the form of the budgets. As such, the Budgetary Control systems acts
as a means of declaration of the policies of the management.
(3)
It acts a means of communication. The plans and objects laid down by top level
management are communicated to middle level and lower level management by way of
the budgets. As such, each and every person working in the organisation is aware of his
duties and responsibilities in relation to those of the others. This maximizes the utilization
of resources.
(4)
It acts as a means of improving the co-ordination. The budgets prepared in the various
functional areas of operations are prepared in such a way that the efforts are co-ordinated
in the direction of achievement of common and defined objective. It develops the team
spirit and help of various people can be sought to solve the common problem.
(5)
The comparison between the budgeted results and the actual results may reveal the
areas where there are adverse variations which may be identified as weak areas or
delicate areas. As such, efforts can be made to remove these adverse variations, keeping
aside the areas where there are no variations. This enables the concentration of efforts of
the management on a smaller portion of activities which facilitates Management by
exception.
(6)
Budgetary control system enables the delegation of authority and makes possible the
principles of Responsibility Accounting.
(7)
It is a powerful tool available to the management for Performance Appraisal. The executives
responsible for those functions where there is favourable variation may be rewarded,
whereas the executives responsible for those functions where there is adverse variation
may be punished. In this sense, budgetary control system provides a basis for
establishment of the incentive systems.
Pre-requisites for the implementation of Budgetary Control

If the organization decides to install the Budgetary Control system as a cost control technique,
it will have to comply with the following preliminaries.
438
(1)
Deciding the Budget Centre :

A Budget Centre is that section of the organization with respect to which the budgets will
be prepared. A Budget centre may be in the form of a product or a department or a
branch of the company and so on. Budget centre should be clearly defined and established
as the budgets will be prepared with respect to each and every Budget Centre.
(2)
Deciding the Budget Period :

A Budget Period is that period of time for which the budget will be prepared and operated.
The selection of the Budget Period should be made very carefully- Too long a budget
period makes the correct estimation more difficult while too short a budget period may
prove to be more costly. The selection of Budget Period may depend upon the nature of
operations and the purpose of preparing the budgets. As such, in case of industries like
the ones engaged in generation and distribution of electricity, transport operations etc.
where capital expenditure is too high, budgets may be prepared even for a period of 5 to
10 years, while in case of industries like the ones engaged in manufacturing of motor
vehicles or radios etc., where the customer demand may change more frequently, the
budget period may be shorter. Similarly, a sales budget may be prepared for a period of
5 years, whereas the short term cash budget may be prepared on weekly or even daily
basis.
(3)
Establishment of Accounting Records :

There should be an efficient and proper system of accounting so that the information and
data as required for the efficient implementation of the Budgetary Control system will be
available in time.
(4)
Organization for Budgetary Control :

A properly prepared organization chart may make the duties and responsibilities of each
level of executive very clear to himself. The budgetary control organization will be headed
by a senior executive in the form of budget controller or budget officer. In small or medium
sized organizations, he himself will be involved in all types of works involved with the
budgetary control system.
However, in case of large organizations, be may have a budget committee under him
which may consist of Chief Executive, budget officer himself and heads of main
departments. The role of budget committee may be only advisory and its decision may
become binding only if accepted by the Chief Executive. The functions performed by the
budget committee can be broadly stated as below.
(a)
To receive and scrutirize the functional budgets.
Budgetary Control
439
(b)
To revise the functional budgets, if necessary.
(c)
To approve the revised budgets.
(d)
To receive the budget reports and comparative statements.
(e)
To locate the responsibilities and recommend the corrective and remedial action.
The usual and normal organization for the budgetary control may be expressed by way
of the following organization chart.
Chief Executive
Budget Officer
Budget committee
Production
Manager
(5)
Personnel
Manager
Finance
Manager
Purchase
Manager
Sales
Manager
Preparation of a budget mannual :

A budget mannual is a document setting out the responsibilities of the persons engaged
in and the forms and procedures required for the budgetary control. A budget manual
enables the standardization of the methods and procedures in relation to the budgetary
control. It should be well written, indexed and divided into the sections. It may be in
bound book form or loose leaf form. A budget mannual may contain the following particulars.
440
(a)
Introduction of principles and objectives of budgetary control and the definitions and
brief explanations.
(b)
Duties and responsibilities of the various executives and the organization chart.
(c)
Functions and duties of budget officer and budget committee.
(d)
Scope of the budget and areas to be covered, whether budget will be a fixed budget
or flexible budget.
(e)
Accounts codes, budget center codes and other codes operated.
(f)
The forms of reports and statements to be used.
(g)
The last date for submission of budgets.
(h)
Budget diagrams.
(6)
Determination of Budget Key Factor :

A budget key factor is that the impact of which should be assessed first before other
functional budgets are prepared to ensure that other functional budgets are capable of
fulfillment. The key factor may take various forms Eg.Sales, Raw material, Labour,
Production capacity, availability of funds and Government restrictions. Once the key
factor is established, the budget with respect to that function will be prepared first and
the other budgets will be prepared to conform to that Eg. If sales is the key factor, the
sales manager will prepare and submit sales forecast first. The production manager will
then decide whether it is possible to produce the quantity to meet sales demand. In
case of the situations where there are more than one key factors, the importance of key
factors themselves will be assessed first. The problem of multiplicity of key factors may
be solved with the help of techniques like linear programming, operations research etc.
TYPES OF BUDGETS :
There can be basically four areas in which management can function and the types of budgets
can be studied with respect to these functional areas of management viz. Sales/Marketing,
production, personnel and finance.
(A)
Sales/Marketing :
The budgets in this area may be of following types.

(I)
Sales Budget :
It is a forecast of total sales expressed in terms of quantity and or money. It is inevitably
the interplay between two factors i.e. sales quantity and selling price. Sales quantity
may be forecasted after taking into consideration various factors.
(1)
Analysis of Past Trend : Analysis of the past trend over the last 5-10 years, may
reveal the long term trends, seasonal trends and the cyclical trends. With the help
of this trend analysis, the future trend can be established. For this purpose, reference
can be made to the reports published by trade organizations and Government
publications.
(2)
Reports by Salesmen : Being in the actual field, probably the sales staff may be
best able to estimate the quantity which can be sold in the market. Before using
this estimate as an official sales forecast, necessary adjustments may be made
for error of judgment or to avoid the possibility of overestimation on the part of the
salesmen.
(3)
Market Research and Market Survey : This is a very specialized technique

available to assess which of the companys products can be sold, in which market,
Budgetary Control
441
in what quantity and at what selling price. Such an analysis will facilitate the
preparation of sales forecast areawise, productwise, salesmenwise and channel of
distribution wise.
(4)
General Economic Conditions : General Trade and Business conditions affect

the sales forecast of the company. They may be in the form of competition from
other companies, supply condition for material and labour, trade conditions of the
customers of the company and so on.
Selling price at which products of the company can be sold may depend upon
various factors viz.
(1)
Cost price of the product
(2)
Selling price charged by the competitors.
(3)
Expected amount of profits.
(4)
Advertisement and other sales promotion efforts carried out by the company.
If the company envisages to sell higher quantity than the past sales or the existing
production capacity, and if some capital investment proposal is involved to increase
the production, then the feasibility of the proposal and the availability of funds may
also be required to be considered. If the sales forecast is less than the past sales
but the top management insists upon a certain amount of additional profits, then
the possibility of increasing the selling price or selling efforts and reduction in the
cost price may be required to be considered.
(II)
Selling and Distribution Cost Budget :

It shows the selling and distribution cost for selling the quantities considered in sales
budget. The sales manager, the distribution manager, the advertising manager and the
finance manager will be the persons involved in the preparation of this budget. This
budget may be prepared on the principles of flexible budgeting (as discussed later in this
chapter) for each head of selling and distribution costs, on the basis of volume of sales
to be achieved.
(III) Advertising Cost Budget :

This cost is closely associated with sales. The intention of incurring this cost is to
increase the sales. However, the result of incurring this cost i.e. increased sales may
not be immediate and even if there is increase in sales, it is difficult to measure the
portion of increased sales which is due to advertising cost. As such, normally, advertising
cost budget is established in the form of a fixed amount for a specific period.
442
The various ways in which the amount of budgeted advertising cost can be decided are
as below :
(1)
Percentage of Sales or Profits : Here the advertising cost may be decided as a

fixed percentage of sales or profits. However, the past data may not be suitable in
view of recent business situations.
(2)
Funds Available : Here the advertising cost depends upon the capability of the
company to spend on advertising. This may be a hypothetical method and may not
necessarily consider the relationship between advertising cost and benefits there
from.
(3)
Competitors Policy : Here the advertising cost may depend upon the amount
which the competitors are spending on advertising. This method may pose some
difficulty as the amount spent by competitors may not be known and it may be
wrong to assume that the company may be able to derive the same benefits from
advertising as the competitors derive.
(B)
Production :
The budgets in this area may be of following types :

(I)
Production Budget :
It is a forecast of production for the budget period. It may be prepared from two angles.
(i)
Production Budget in terms of Quantity.
(ii)
Production Budget in terms of money i.e. the production Cost Budget further
classified under each element of cost such as Direct Material Cost, Direct Labour
Cost and Overheads Cost.
The material cost can be estimated by preparing the materials budget which indicates
the estimated quantities as well as costs of various materials required for carrying out
production as per production budget.
The labour cost can be estimated by preparing Direct Labour Cost budget which indicates
the direct labour requirements required to produce the quantity as specified in the
production budget. For the purpose of this budget, labour requirement in terms of number
of workers of different grades will be decided first. Afterwards, the rates of pay and
allowances will be considered to decide the labour cost. The production overheads can
be estimated by preparing production overhead budget which indicates all items of
production overheads classified as fixed, variable and semi-variable. The process of
allocation and apportionment can be followed to decide the loading of overheads to each
budget centre. Following factors will have to be considered before preparing the production
budget in terms of quantity.
Budgetary Control
443
(1)
Coordination with Sales Forecast : Before the quantity to be produced is decided,

it will be necessary to confirm whether it is possible to sell the quantity which is
produced during the budget period. If it is not possible to sell whatever can be
produced, inspite of all the sales promotion efforts, then the production budget
should be adjusted to conform to the sales forecast. If the expected sales exceed
existing production capacity, possibility of overtime working or extra shift working
should be considered.
(2)
Production Capacity : Production Budget estimates the quantity to be produced.

If it is not possible to produce the quantity with the existing capacity available, it
will be necessary to increase the capacity by incurring additonal capital expenditure.
(3)
Consideration of Stocks : Whatever is to be sold need not be produced necessarilly.

The quantity to be produced, after giving due consideration to the sales forecast,
may depend upon the opening and closing stock of finished goods. The quantity to
be produced during the budget period may be decided as Estimated Closing stock of finished goods.
Add : Quantity to be sold,
Less : Opening Stock of Finished Goods.
(4)
(II)
Management Policy : Sometimes, the policy decisions taken by the management

are required to be considered before setting the production budget Eg. It will have to
be considered whether certain components are decided to be produced instead of
purchasing or vice versa.
Purchases Budget :
It is a forecast of quantity and value of materials, direct or indirect, required to be purchased
during the budget period. It is needless to state that the purchases budget is closely
connected to the production budget. Following factors are required to be considered
before setting the purchases budget,
444
(1)
Orders already placed for the purchases of materials.
(2)
Material already purchased but reserved for some specific purposes.
(3)
Opening and closing stocks.
(4)
Storing facilities and economic order quantity.
(5)
Availability of funds.
(6)
Prices of the materials.
(C)
Personnel :
In this functional area, the budget to be prepared takes the form of a personnel budget, which
indicates the requirement of personnel or labour force, either direct or indirect, to conform to
the sales forecast and the production budget. The labour requirement may be decided in
terms of number and grade of workers, number of labour hours, rupee value etc. Consideration
is also required to be made of the overtime working or shift working. This budget may also
indicate the training plans for new workers.
(D)
Finance :
The most important budget which is prepared under this functional area is the cash budget. It
is an estimate of the expected cash receipts and cash payments during the budget period.
Thus by preparing the cash budget, it is possible to predict whether at any point of time, there
is likely to be excess or shortage of cash. If the shortage of cash is estimated, it may be
required to arrange the cash from some other source. If the excess of cash is estimated, it
may be possible to explore the investment opportunities. Before preparing the cash budget,
following principles should be kept in mind.
(i)
The period for which cash budget is prepared should be selected very carefully. There is
no fixed rule as to the period to be covered by the cash budget. It may vary from company
to company depending upon the individual requirements. As a general rule, the period
covered by the cash budget should neither be too long or too short. If it is too long, it is
possible that the estimate will not be accurate. If it is too short, the factors which are
beyond the control of management will not be given due consideration.
(ii)
The items which should appear in the cash budget, should be carefully decided. Naturally,
all those items which do not involve cash flow will not be considered while preparing the
cash budget. Eg. As the cost of depreciation does not involve any cash outflow, it does
not affect the cash budget, though the amount of depreciation affects the determination
of tax liability which involves cash outflow.
A cash budget may be prepared in any of the following three methods.
(1)
Receipts and Payments Method : This method is useful for short term estimations.
It lists the various estimated sources of cash receipts on one hand and the various
estimated applications of cash on the other.
While preparing the cash budget by this method, the various items appearing on
the same may be classified under the following two categories :
(i)
Operating Cash Flows : These are the items of cash flow which arise as a
result of regular operations of the business.
Budgetary Control
445
(ii)
Non operating Cash Flows : These are the items of cash flow which arise
as the result of other operations of the business.
The standard items which may appear on the cash budget prepared by this method may
be stated as below :
Cash Inflow
Operating :
Cash Outflow
Operating :
Cash sales
Collection from debtors
Interest/Dividend received
Payment to creditors
Cash Purchases of raw materials
Wages/Salaries
Various kinds of overheads.
(To the extent they are actually paid)
Non-operating
Non-operating
Issue of shares/debentures
Receipt of loans/borrowings
Sales of Fixed Assets
Sales of Investments
Redemption of shares/debentures.
Loan Installments
Purchases of Fixed Assets
Interest
Taxes
Dividends.
Thus, finally cash budget appears in the form of opening cash balance, to which
various estimated cash receipts are added, the estimated cash payments being
deducted from this sum to arrive at the closing cash balance.
446
(2)
Balance Sheet Method : This method is useful for long term estimates. According
to this method, the budgeted Balance Sheet is prepared for the following budget
period, after considering the various terms viz. Capital, Long Term Liabilities, Current
liabilities, Fixed Assets, Current Assets, but except cash. After both the sides of
Balance Sheet are balanced, the balancing figure indicates the estimated cash
balance in hand at the end of that period. This method does not consider the
expenses and assumes the regular pattern of inflow and outflow of cash. Further, it
indicates the cash requirement only at the end of budget period, any excess or
shortage of cash during the budget period are not considered.
(3)
Adjusted Profits/Losses Method : This method also is useful for long term
estimates. According to this method, the cash budget is prepared in the following
way to show the estimated cash balance at the end of the budget period.
Opening cash balance.

Add : Profit before depreciation, provisions and other non-cash expenses.
Add : Decrease in Current Assets or Increase in Current Liabilities.
Add : Capital Receipts.
Add : Receipt of loans/borrowings
Less : Capital Expenditure
Less : Repayment of loan installments
Less : Payment of dividends/taxes
Less : Increase in Current Assets or Decrease in Current Liabilities
In other words, cash budget prepared as per this method is in the form of cash flow
statement.
(E)
Miscellaneous Budgets :
In addition to the various budgets as described above, which can be prepared in prime
functional areas of marketing, production, personnel and finance, some other types of
budgets may also be prepared.
(I)
Overheads Cost Budget :

It indicates the various types of overheads to be incurred during the budget period.
For the correct establishment of overheads cost budget, it will be necessary to
classify the various overheads. In order to exercise proper control on the overheads,
it will be necessary to analyse the overheads as fixed, variable and semi-variable.
The semi-variable overheads are further required to be split into fixed and variable
elements.
(II)
Capital Expenditure Budget :

It is the plan of proposed investment in the fixed assets. It is closely related to the
sales budget, production budget and cash budget. As such, capital expenditure
budget should be properly coordinated with other functional budgets.
The capital expenditure may be required to be incurred for the replacement purposes
or expansion purposes. The requirements of capital expenditure may be basically
received from the various functional executives viz. production manager, sales
manager, finance manager and so on. If the investment in fixed assets is considered
to be economically and financially feasible, then the arrangement is required to be
made for the acquisition of the same. If the cash budget reveals the excess funds
available, it may not be necessary to arrange the funds for acquiring the fixed
assets from outside source. However, if no excess cash balance is available, then
it may be necessary to borrow the funds from some outside source.
Budgetary Control
447
(F)
Master Budget :
After all the functional budgets are prepared individually and are properly coordinated with
each other, the master budget can be prepared by incorporating all the functional budgets.
The ultimate incorporation of all the functional budgets takes the form of budgeted Profit and
Loss Account and the Budgeted Balance Sheet.
It may involve the presentation of current years budgeted figures as well as those of the
previous year showing clearly why there is a change.
FIXED AND FLEXIBLE BUDGETS :
Any budget in any functional area of operation can be established as a fixed budget or a
flexible budget. A fixed budget is established for a specific level of activity and is not adjusted
to the actual level of activity attained at the time of comparison between the budgeted and
actual results. Naturally, fixed budget is established only for a short period of time where the
budgeted level of activity is expected to be attained to the maximum possible extent. Fixed
budgets are more suitable for fixed expenses i.e. the expenses which have no relation with the
level of activity. The fixed budgets do not indicate that they cannot be changed at all. A fixed
budget can be revised if the actual level of activity is likely to differ widely from the budgeted
level of activity. The fixed budget cannot be used as a effective tool of cost control while
computing the variations between the budgeted result and the actual result, the variance
cannot be explained properly and it is not possible to say whether the variance is due to the
changes in the level of activity or due to the efficiency or inefficiency of the executive responsible
for the execution of the budget. A flexible budget is designed to change with the fluctuations
in the level of activity and provides a basis for comparison for any level of activity actually
attained. A flexible budget is more elastic, and practical. It can be properly used as an effective
tool for evaluation of performance and cost control. It explains the variations between the
budgeted results and actual results stating the variations which are due to changes in the level
of activity (which is beyond the control of operating executive) and which are due to the
operational efficiency or inefficiency (for which the operating executive is responsible.)
For the purpose of establishment of the flexible budgets, it is necessary to classify the costs
as fixed costs, variable costs and semi-variable costs. The fixed costs remain the same at all
the levels of activity whereas the variable costs change directly in proportion to the level of
activity. So far as the semi-variable costs are concerned, each item of cost is examined and
classified into its fixed and variable elements and a trend is established regarding the nature
and behavior of each item of cost.
(1)
448
An estimate shows that there is a market for 10,00,000 units of an electric bell. Two big
companies producing this electric bell will probably divide 80% of the market. Among
other companies, producing the bell, Ghatanad Ltd. should get 15% of the total market.
60% of the Ghatanad sales will probably be evenly divided between the first and last
calendar quarters, with twice as many sales being made in the second quarter as in the
third.
The bell sells for Rs.30 an unit, with the manufacturing cost as follows. The cost is
worked out with reference to normal working capacity for the production which is 1,50,000
bells a year.
Rs.
15.00
Direct Labour Cost
Rs.
7.50
Variable overheads cost
Rs.
2.50
Fixed overhead cost
Rs.
1,00,000
Prepare a sales budget for the year showing cost of production and gross profit by
calendar quarters. Assume no change in the inventory levels during the year.
Solution :
SALES BUDGET
Particulars
Qtr. I
Qtr. II
Qtr. III
Qtr. IV
Total
45,000
40,000
20,000
45,000
1,50,000
13,50,000
12,00,000
6,00,000
13,50,000
45,00,000
Direct Materials Rs.
6,75,000
6,00,000
3,00,000
6,75,000
22,50,000
Direct Labour Rs.
3,37,500
3,00,000
1,50,000
3,37,500
11,25,000
Variable Overheads Rs.
1,12,500
1,00,000
50,000
1,12,500
3,75,000
25,000
25,000
25,000
25,000
1,00,000
11,50,000
10,25,000
5,25,000
11,50,000
38,50,000
2,00,000
1,75,000
75,000
2,00,000
6,50,000
(A) Sales - Units

Rs.
(B) Cost of Production
Fixed Overhead Rs.
(c) Gross Profit i.e. A - B
Note : It is assumed that the fixed overheads are apportioned evenly over the various quarters.
(2)
XYZ Ltd. manufactures product C and G. During January, it expects to sell 5,000 Kgs of
C and 20,000 Kgs of G at Rs. 20 and Rs. 10 each respectively.
Direct materials A, B and E are mixed in equal proportion to produce product C. Materials D,
B and E are mixed in the proportion of 5:3:2 to produce product G. There is no loss of weight
in the production.
Budgetary Control
449
Actual and budgeted inventories in quantities and costs for the month are as follows :
Material
Product
Opening Inventory
Kgs.
Desired Closing
Inventory Kgs.
Anticipated Cost
per kg.
1,500
1,000
5.50
1,000
2,000
5.00
10,000
3,000
1.00
5,000
6,000
3.50
1,000
500
5,000
6,000
You are required to prepare (i) the production budget (ii) the materials purchase budget, indicating
the expenditure on raw materials for January.
Solution :
(A) Production Budget : January 1987
Product C
Product G
5,000
20,000
500
6,000
5,500
26,000
Less : Opening stock kgs.
1,000
5,000
Production during month kgs.
4,500
21,000
Anticipated Sales - kgs.

Desired closing stock - kgs
(B) Materials Purchase Budget - January 1987
(a)
(b)
(c)
(d)
(e)
(f)
(g)
450
Requirement for production

(As per production Budget)
For product C - kgs
For product G - kgs.
Total requirement - kgs.
Desired closing stock - kgs
Sub total a +b kgs
Opening stock kgs
To be purchased during month kgs. c - d
Anticipated cost per kg. Rs.
Anticipated cost of purchases Rs.
1,500
1,500
1,000
2,500
1,500
1,000
5.50
5,500
1,500
6,300
7,800
2,000
9,800
1,000
8,800
5.00
44,000
10,500
10,500
3,000
13,500
10,000
3,500
1.00
3,500
1,500
4,200
5,700
6,000
11,700
5,000
6,700
3.50
23,450
(3)
Lookahead Ltd. produces and sells a single product. Sales budget for the calender year
1987 by quarter is as under Quarter
No. of units to be sold
12,000
II
15,000
III
16,500
IV
18,000
The year 1987 is expected to open with an inventory of 4,000 units of finished product and
close with an inventory of 6,500 units. Production is customarily scheduled to provide for two
third of the current quarter s sales demand plus one third of the following quarters demand.
Thus production anticipates sales volume by about one month.
The standard cost details for one unit of the product is as below
Direct Materials 10 Ibs @50 paise per Ib.
Direct Labour 1 hour 30 minutes @Rs. 4 per hour.
Variable Overheads 1 hour 30 minutes @Re. 1 per hour.
Fixed Overheads 1 hour 30 minutes @Rs. 2 per hour, based on a budgeted production volume
of 90,000 direct labour hours for the year.
a.
Prepare a production budget for 1987, by quarters, showing the number of units to be
produced and the total costs of direct material, direct labour, variable overheads and
fixed overheads.
b.
If the budgeted selling price per unit is Rs. 17, what would be the budgeted profit for the
year as a whole ?
c.
in which quarter of the year is the company expected to break even ?
Solution :
a.
Production Budget
We know that Opening Stock + Production - Sales = Closing Stock
Hence we know that
Closing Stock + Sales - Opening Stock = Production
Budgetary Control
451
Q1
Q2
Q3
Q4
4000
5000
5500
6000
Production
13000
15500
17000
18500
Sales
12000
15000
16500
18000
5000
5500
6000
6500
Opening Stock
Closing Stock
Hence, the total production for all the quarters will be 64,000 units.
b.
Production Cost Budget -
Rs.
Direct Materials
64000 units x Rs. 5
3,20,000
Direct Labour
96000 hours x Rs. 4
3,84,000
Variable Overheads
96000 hours x Re. 1
96,000
Total Variable Cost
8,00,000
Fixed Cost
1,80,000
Total Cost
9,80,000
Total Variable Cost for 64000 units is Rs. 8,00,000. Hence, per unit variable cost is
Rs. 12.50.
c.
Calculation of Profit
Sales 61500 units @Rs. 17 per unit
10,45,500
Variable Cost of units sold

61500 units @Rs. 12.50 per unit
7,68,750
Contribution
2,76,750
Less : Fixed Cost
1,80,000
Profit
d.
96,750
Break Even Point

Per Unit Selling Price is Rs. 17 and Per Unit Varaible Cost is Rs. 12.50. Hence, Per Unit
Contribution Rs. 4.50.
As Fixed Cost is Rs. 1,80,000, Break Even Point in units will be 180000 / 4.50 = 40000
units. This target is achieved by the company in Quarter 3, hence the company is
expected to break even in Quarter Three.
(4)
452
A single product company estimated its sales for the next year quarterwise as under -
Quarter
Sales units
30,000
II
37,500
III
41,250
IV
45,000
The opening stock of the finished goods is 10,000 units and the company expects to maintain
the closing stock of finished goods at 16,250 units at the end of the year. The production
pattern in each quarter is based on 80% of the sales of the current quarter and 20% of the
sales of the next quarter.
The opening stock of raw materials in the begining of the year is 10,000 Kgs. and the closing
stock at the end of the year is required to be maintained at 5,000 Kgs. Each unit of finished
output requires 2 Kgs. of raw material.
The company proposes to purchase the entire annual requirement of raw materials in the first
three quarters in the proportion and at the prices given below Quarter
Purchases of raw materials
Price per Kg.
% of total annual requirement
Rs.
in quantity
I
30%
II
50%
III
20%
The value of the opening stock of raw materials in the beginning of the year is Rs. 20,000.
You are required to present the following for the next year, quarterwise a.
Production Budget in units.
b.
Raw Materials consumption budget in quantity.
c.
Raw Materials purchase budget in quantity and value.
Solution :
a.
Production Budget
We know that Opening Stock + Production - Sales = Closing Stock Hence we know that
Closing Stock + Sales - Opening Stock = Production
Budgetary Control
453
Q1
Q2
Q3
Q4
Opening Stock
10000
11500
12250
13000
Production
31500
38250
42000
48250
Sales
30000
37500
41250
45000
Closing Stock
11500
12250
13000
16250
Hence, the total production for all the quarters will be 1,60,000 units.
b.
Raw Materials Consumption Budget

Production Budget is 1,60,000 units. Each unit of the final product requires 2 Kgs. of raw
material. Hence, the raw material consumption budget in quantity will be 3,20,000 Kgs.
c.
Raw Materials Purchase Budget

Total quantity of raw materials to be purchased will be
Closing Stock + Consumption - Opening Stock
5000 + 320000 - 10000 = 315000
The quarterwise purchases will be as below Q1 30% of 315000 Kgs. i.e 94500 Kgs. @Rs. 2 per Kg.
1,89,000
Q2 50% of 315000 Kgs. i.e. 157500 Kgs. @Rs. 3 per Kg.
4,72,500
Q3 20% of 315000 Kgs. i.e. 63000 Kgs. @Rs. 4 per Kg.
2,52,000
9,13,500
Hence, total purchase budget in terms of value is Rs. 9,13,500.

(5)
A private Limited company is formed to take over a running business. It has decided to
raise Rs.55 Lakhs by issue of Equity shares and the balance of the capital required in
the first six months is to be financed by a financial institution against an issue for Rs.5
Lakhs 8% Debentures (Interest payable annually) in its favour.
Initial outlay consists of
Freehold premises
Rs.
25
Lakhs
Plant & Machinery
Rs.
10
Lakhs
Stock
Rs.
Lakhs
Vehicle & Other items
Rs.
Lakhs
Payments on the above items are to be made in the month of incorporation. Sales during
the first 6 months ending on 30th June are estimated as under.
454
January
Rs.
14
Lakhs
April
Rs.
25
Lakhs
February
Rs.
15
Lakhs
May
Rs.
26.50
Lakhs
March
Rs.
18.50
Lakhs
June
Rs.
28
Lakhs
Lag in payment
- Debtors 2 months
- Creditors 1 month
Other information :
(1)
Preliminary expenses Rs.50,000 (Payable in February)
(2)
General Expenses Rs.50,000 p.m.(Payable at the end of each month)
(3)
Monthly wages (payable on 1st day of next month) Rs. 80,000 p.m. for first
3 months and Rs. 95,000 p.m. there after.
(4)
Gross Profit rate is expected to be 20% on sales.
(5)
The shares and debentures are to be issued on 1st January.
(6)
The stock levels throughout is to be the same as the outlay.

Prepare cash budget for the 6 months ended 30th June.
Solution :
Cash Budget
(For 6 month sending 30th June)
(A) Cash Inflow

Issue of shares
Issue of Debentures
Collection from Debtors
(B) Cash Outflow
Fixed Assets
Stock (Initial)
Preliminary Expenses
Sundry Creditors
General Expenses
Wages
(C) Net cash Inflows
(A-B)
Opening Balance
+ Surplus for the month
Closing Balance
Budgetary Control
(Rs. in Lakhs)
May
Jun
Jan.
Feb.
Mar.
Apr.
55.00
5.00
60.00
14.00
14.00
15.00
15.00
18.50
18.50
25.00
25.00
40.00
6.00
0.50
46.50
0.50
10.40
0.50
0.80
12.20
11.20
0.50
0.80
12.50
14.00
0.50
0.80
15.30
19.05
0.50
0.95
20.50
20.25
0.50
0.95
21.70
13.50 (12.20)
13.50
13.50 (12.20)
13.50
1.30
1.50
1.30
1.50
2.80
(0.30)
2.80
(0.30)
2.50
(2.00)
2.50
(2.00)
0.50
3.30
0.50
3.30
3.80
455
Working Notes :
(1)
It is assumed that the company is incorporated in January.
(2)
Assuming that the company is carrying on manufacturing operations, the purchase

say for the month of January are computed as below.
Sales for January
14.00
Less Gross profit @ 20%
2.80
Cost of goods
11.20
Less wages for January
0.80
Purchases
(6)
10.40
A newly started company Green Co. Ltd. wishes to prepare cash budget from January.
Prepare a cash budget for the first 6 months from the following estimated revenue and
expenditure.
Month
Total
Sales
Material
Wages
Overheads
Production
Selling &
Distribution
Rs.
Rs.
Rs.
Rs.
Rs.
Jan.
20,000
20,000
4,000
3,200
800
Feb.
22,000
14,000
4,400
3,300
900
Mar.
24,000
14,000
4,600
3,300
800
Apr.
26,000
12,000
4,600
3,400
900
May
28,000
12,000
4,800
3,500
900
June
30,000
16,000
4,800
3,600
1000
Cash balance on 1st January was Rs.10,000. A new machine is to be installed at

Rs.30,000 on credit, to be repaid by two equal installments in March and April.
Sales commission @ 5% on total sales is to be paid within the month following actual
sales. Rs. 10,000 being the amount of second call may be received in March. Share
premium amounting to Rs. 2,000 is also obtainable with 2nd call.
Period of credit allowed by suppliers
2 month
period of credit allowed to customers
1 month
Delay in payment of overheads
1 month
Delay in payment of wages
1/2 month
Assume cash sales to be 50% of total sales.
456
Solution :
Cash Budget of Green Co. Ltd.
Jan.
Feb.
Mar.
Apr.
10,000 11,000
12,000
13,000
14,000 15,000
- 10,000
11,000
12,000
13,000 14,000
Share Capital (2nd call)
10,000
Share Premium
2,000
10,000 21,000
35,000
25,000
27,000 29,000
14,000 12,000
(A) Cash Inflows

Cash sales
May
Jun.
(B) Cash Outflows

Sundry Creditors
20,000
14,000
2,000
2,200
2,300
2,300
2,400
2,400
For last month
2,000
2,200
2,300
2,300
2,400
3,200
3,300
3,300
3,400
3,500
800
900
800
900
900
purchased
15,000
15,000
Sales commission
1,000
1,100
1,200
1,300
1,400
2,000
9,200
44,800
38,900
Wages For current month
Selling & Distribution

Overheads
Instalment for Machine
(C) Net Cash Inflows

or outflows
(A-B)
Opening cash balance
8,000 11,800
10,000 18,000
+ Surplus for month

Closing cash balance
(7)
8,000 11,800
18,000 29,800
(-) 9800 (-) 13,900
24,300 22,600
2,700
6,400
20,000
6,100
8,800
(-) 9,800 (-) 13,900
2,700
6,400
29,800
20,000
6,100
8,800 15,200
Prepare a cash budget for the quarter ended 30th September 1987 based on the following
information
Cash at Bank on 1st July 1987
Rs.
25,000
Salaries and wages estimated monthly
Rs.
10,000
Interest Payable August 1987
Rs.
5,000
Budgetary Control
457
June
Rs.
July
Rs.
August
Rs.
September
Rs.
1,40,000
1,52,000
1,21,000
Credit Sales
1,00,000
80,000
1,40,000
1,20,000
Purchases
1,60,000
1,70,000
2,40,000
1,80,000
20,000
22,000
21,000
Estimated Cash sales
Other Expenses
(Payable in same month)
Credit sales are collected 50% in the month of sales are made and 50% in the month following.
Collection from credit sales are subject to 5% discount if payment is received in the month of
sales and 2.5% if payment is received in the following month.
Creditors are paid either on a prompt or 30 days basis. It is estimated that 10% of the creditors
are in the prompt category.
Solution :
Cash Budget
(For Quarter ending September 1987)
(A) Cash Inflows

Cash Sales
Collection from Debtors
Last month
Current month
(B) Cash Outflows

Sundry Creditors
Prompt Basis
Others
Salaries & wages
Other Expenses
Interest
(C) Net Cash Inflow (A-B)

Opening Balance
+ Surplus for the month
Closing Balance
458
July
Rs.
August
Rs.
September
Rs.
1,40,000
1,52,000
1,21,000
48,750
38,000
39,000
66,500
68,250
57,000
2,26,750
2,57,500
2,46,250
17,000
1,44,000
10,000
20,000
-
24,000
1,53,000
10,000
22,000
5,000
18,000
2,16,000
10,000
21,000
-
1,91,000
2,14,000
2,65,000
35,750
43,500
(18,750)
25,000
35,750
60,750
60,750
43,500
1,04,250
1,04,250
(18,750)
85,500
Working Notes :
It is assumed that salaries and wages are paid in the same month.
(8)
From the following information you are required to prepare a cash budget for six months
from January 1987 to June 1987, Month by month, showing also the cash credit facility
available from the Bank. Opening overdrawn balance is Rs. 1,50,000.
Month
Sales
Materials
Wages
Purchases
Prod.
Selling &
Adm.
Expenses
Dist.
Expases
Rs.
Rs.
Rs.
Rs.
Expenses
Rs.
Rs.
January
1,44,000
50,000
20,000
12,000
8,000
3,000
February
1,94,000
62,000
24,200
12,600
10,000
3,400
March
1,72,000
51,000
21,200
12,000
11,000
4,000
April
1,77,200
61,200
50,000
13,000
13,400
4,400
May
2,05,000
74,000
44,000
16,000
17,000
5,000
June
2,17,400
77,600
46,000
16,400
18,000
5,000
Following further information is available.

(1)
Out of total sales, 50% are cash sales and balance 50% is received in the month following
month of sale.
(2)
Payment for purchase of assets is to be made Rs.16,000 in February, Rs. 25,000 in

March and Rs. 50,000 in April.
(3)
Proceeds from sales of scrap are to be received in May, amounting to Rs.6,000.
(4)
Dividend of Rs. 90,000 is to be paid in June.
(5)
Sales commission is to be paid at 3% of total sales in same month in which sales are
made.
(6)
Suppliers for materials are paid in the month following the month of purchases of materials.
(7)
Cash credit facility granted is Rs. 2,00,000.
(8)
Wages are paid in the same month.
(9)
Creditors of Production, Selling & Distribution and Administration expenses are given
one months credit period.
Budgetary Control
459
Solution :
(A)
Jan.
Feb.
Mar.
Apr.
May
Jun.
87
87
87
87
87
87
72,000
-
97,000
72,000
86,000
97,000
88,600
86,000
1,02,500
88,600
1,08,700
1,02,500
6,000
72,000
1,69,000
1,83,000 1,74,600
1,97,100
2,11,200
50,000
62,000
51,000
61,200
74,000
20,000
24,200
21,200
50,000
44,000
46,000
Production Expenses
Sales & Dist. Expenses
12,000
8,000
12,600
10,000
12,000
11,000
13,000
13,400
16,000
17,000
Admin Expenes
3,000
3,400
4,000
4,400
5,000
Purchases of Assets
Dividend
16,000
-
25,000
-
50,000
-
90,000
4,320
5,820
5,160
5,316
6,150
6,522
24,320
1,19,020
1,39,360 1,83,316
1,42,150
2,54,522
47,680
49,980
43,640
(-)8,716
54,950 (-) 43,322
1,50,000
1,02,320
52,340
8,700
17,416 (-) 37,534
47,680
49,980
43,640 (-) 8,716
54,950 (-) 43,322
1,02,320
52,340
Cash Inflows
Cash sales
Sales of scrap
(B)
Cash Outflows
Creditors for Materials
Wages
Sales Commission
(c)
Net Cash
inflows or
outflows
(A-B)
Opening over drafting
+Surplus/Deficit
for the month
Closing overdrawing
8,700
17,416 (-) 37,534
5,788
Note :
Eventhough, the Cash Credit Facility is granted to the extent of Rs.2,00,000, the company is
not likely to utilise it fully. At the end of June 1987, the overdrawn balance is likely to be only
Rs.5,788.
(9)
460
ABC Co. Ltd. wishes to arrange overdraft facilities with its bankers during the period April
to June 1987 when it will be manufacturing mostly for stock. Prepare a cash budget for
the above period from the following data, indicating the extent of the bank facility the
company will require at the end of each month.
Month
Sales
Rs.
Purchases
Rs.
Wages
Rs.
February
1,80,000
1,24,800
12,000
March
1,92,000
1,44,000
14,000
April
1,08,000
2,43,000
11,000
May
1.74,000
2,46,000
10,000
June
1,26,000
2,68,000
15,000
Additional Information :
(1)
All Sales are Credit Sales 50% of Credit Sales are realised in the month following the
sales and the remaining 50% in the Second month following.
(2)
Creditors are paid in the month following the month of purchases.
(3)
Cash at Bank of 1.4.87 (Estimated) Rs.25,000.
Solution :
Cash Budget of ABC Co. Ltd.
Apr. 87
May 87
June 87
First 50%
96,000
54,000
87,000
Second 50%
90,000
96,000
54,000
1,86,000
1,50,000
1,41,000
1,44,000
2,43,000
2,46,000
11,000
10,000
15,000
1,55,000
2,53,000
2,61,000
31,000
(-) l,03,000
(-) l,20,000
Opening Cash Balance
25,000
56,000
(-) 47,000
+ Surplus/Deficit for the month
31,000
(-) l,03,000
(-) l,20,000
Closing cash balance
56,000
(-) 47,000
(-) 1,67,000
(A) Cash Inflows

Sundry Debtors
(B) Cash Outflows

Sundry Creditors
Wages
(C) Net Cash Inflows

or outflows (A-B)
(D) Estimated Cash Surplus
or shortage
Budgetary Control
461
Note : It can be seen that the company will be required to arrange for the bank finance of
Rs. 47,000 at the end of May 1987 and an additional amount of Rs.1,20,000 at the end of
June 1987.
(10) The manager of a Repairs and Maintenance Department has submitted the following
budget estimates that are to be used to construct a flexible budget to be used during the
coming budget year.
Details of cost
Planned at 6000
direct repairs
hours
Planned at 9000
direct repairs
hours
Employee Salaries
30,000
30,000
Indirect Repair Materials
40,200
60,300
Miscellaneous Costs
13,200
16,800
a.
Prepare a flexible budget for the department up to activity level of 10,000 repair hours
(use increment of 1000).
b.
What would be the budget allowance at 8,500 repair hours?
Solution :
8500 Hours
10000 Hours
Employee Salaries
30,000
30,000
Indirect Repair Materials
56,950
67,000
Miscellaneous Costs
16,200
18,000
1,03,150
1,15, 000
Working Notes :
From the analysis of the costs, it is observed that -
462
a.
Employee salaries is a fixed cost as they remain constant for both 6000 repair hours and
9000 repair hours.
b.
Indirect repair materials is a variable cost as it proportionately increases from 6000

hours to 9000 hours.
c.
Miscellaneous costs is a semi-variable cost. This cost neither remained constant nor
increased proportionately the activity level of 6000 hours to 9000 hours. The cost increased
by Rs. 3,600 for the increase of 3000 hours. means that the variable portion of this cost
is Rs. 1.20 hour. Hence, out of total miscellaneous cost of Rs. 13,200 for 6000 hours,
Rs. 7,200 is variable portion and balance 6,000 is the fixed portion.
(11) Viveka Elementary School has a total of 150 students consisting of 5 sections with 30
students per section. The school plans for a picnic around the city during the week end
to places such as the zoo, the amusement park, the planetarium etc. A private transport
operator has come forward to lease out the buses for taking the students. Each bus will
have a maximum capacity of 50 (excluding 2 seats reserved for the teacher accompanying
the students). The school will employ 2 teachers for each bus paying them an allowance
of Rs. 50 per teacher. It will also lease out the required number of buses. The following
are the other cost estimates Cost per student
Rs.
Breakfast
Lunch
5
10
Tea
Entrance fee at zoo
Rent Rs. 650 per bus.

Special permit fee Rs. 50 per bus.
Block entrance fee of the planetarium Rs. 250.
Prizes to the students for games Rs. 250.
No costs are incurred in respect of the accompanying teachers (except the allowance of
Rs. 50 per teacher).
You are required to prepare a.
A flexible budget estimating the total cost for the levels of 30, 60, 90, 120 and 150
students. Each item of cost is to be indicated separately.
b.
Compare the average cost per student of these levels.
c.
What will be your conclusions regarding the break even level of students if the school
proposes to collect Rs. 45 per student?
Budgetary Control
463
Solution :
No. of Students
30
60
90
120
150
600
1200
1800
2400
3000
Rent of the bus
650
1300
1300
1950
1950
Permit Fees
Allowances to teachers
50
100
100
200
100
200
150
300
150
300
Entrance Fees
250
250
250
250
250
Prizes to students
250
250
250
250
250
1900
3300
3900
5300
5900
63.33
55.00
43.33
44.17
39.33
a.
Variable Cost
b.
Semi-fixed costs
c.
Fixed Costs
Total Costs
Average Cost per student
Total Cost
No. of students
(12) Prepare the flexible budget for overheads on the basis of data given below. Ascertain the
overheads rates at 50%, 60% and 70% capacity.
At 60% capacity
Rs.
Variable Overheads
Indirect Material
6,000
Indirect Labour
18,000
Semi-Variable Overheads
Electricity
(40% fixed, 60% variable)
30,000

(80% fixed, 20% variable)
3,000
Fixed Overheads :
Depreciation
Insurance
4,500
Salaries
15,000
Total Overheads
93,000
Estimated Direct Labour Hours
464
16,500
1,86,000
Solution :
Calculation of Overheads Rates
50%
Capacity
Rs.
60%
Capacity
Rs.
70%
Capacity
Rs.
Indirect Material
5,000
6,000
7,000
Indirect Labour
15,000
18,000
21,000
27,000
30,000
33,000
2,900
3,000
3,100
16,500
16,500
16,500
4,500
4,500
4,500
Salaries
15,000
15,000
15,000
Total Overheads
85,900
93,000
1,00,100
1,55,000
1,86,000
2,17,000
Re.0.55
Re.0.50
Re.0.46
Variable Overheads
Semi Variable Overheads

Electricity
Fixed Overheads
Depreciation
Insurance
Estimated Direct
Labour Hours
Overhead Rate
(Labour Hour Rate)
(13) A Factory can produce 60,000 units per annum at its 100% capacity. The estimated
costs of production are as under.
Direct Materials
Rs. 3 per unit.
Direct Labour
Rs. 2 per unit
Indirect Expenses
Fixed
Rs. 1,50,000 per annum
Variable
Rs. 5 per unit
Semi-variable
Rs. 50,000 per annum up to 50% capacity and an

extra expenses of Rs. 10,000 for every 20% increase
in capacity or part thereof.
The factory produces only against orders. If the production programme of the factory is as
indicated below, and the management desires to ensure a profit of Rs.1,00,000 for the year,
work out the average selling price at which each unit should be quoted.
Budgetary Control
465
For three months of the year - 50% capacity

Remaining nine months of the year - 80% capacity
Solution :
Calculation of total cost
50%
capacity
80%
capacity
Total
capacity
7,500
36,000
43,500
Direct Material - Rs.
22,500
1,08,000
1,30,500
Direct Labour - Rs.
15,000
72,000
87,000
Variable Expenses - Rs.
37,500
1,80,000
2,17,500
Fixed Expenses
37,500
1,12,500
1,50,000
Semi-Variable Expenses - Rs.
12,500
32,500
45,000
1,25,000
5,05,000
6,30,000
Number of units produced
Total Cost
Thus, the total cost during the year is likely to be Rs.6,30,000. If it is desired to earn a profit
of Rs. 1,00,000 the total amount to be covered by the units to be sold will have to be Rs.7,30,000
(i.e. Rs. 6,30,000 + Rs. 1,00,000). As the total units produced are estimated to be 43,500,
the above amount will have to be covered by 43,500 units. Hence, the average selling price per
unit will be
Rs.7,30,000
43,500
Rs. 16.78 per unit (approx.)
Notes :
(1)
It is assumed that whatever units are produced can be sold.
(2)
It is assumed that the production and the incidence of all the indirect expenses is equally
spread during the year.
(3)
From the following particulars, prepare a flexible budget for the three months ending
30th September showing the estimated sales, sales cost and profit for 60%, 80% and
100% activity. Assume that all items produced are sold.
Fixed Expenses
Rs.
Management salaries
4,20,000
Rent and Taxes
2,80,000
Depreciation on machinery
3,50,000
Sundry office cost
4,45,000
14,95,000
466
Rs.
Semi-variable expenses
at 50% capacity
Plant Maintenance
1,25,000
Indirect Labour
4,95,000
Salesmens Salary & Expenses
1,45,000
Sundry Expenses
1,30,000
8,95,000
Variable Expenses
at 50% capacity
Materials
12,00,000
Labour
12,80,000
Salesmens Commission
1,90,000
26,70,000
Semi-variable expenses remain constant between 41% and 70% activity, increase by 10% of
the above figures between 71% and 80% activity and increase by 15% of the above figures
between 81% and 100% activity. Fixed expenses remain constant whatever may be the level
of activity. Sales at 60% activity are Rs.51,00,000, at 80% activity are Rs. 68,00,000 and at
100% activity are Rs.85,00,000.
Flexible Budget
60%
capacity
Rs.
80%
capacity
Rs.
100%
capacity
Rs.
51,00,000
68,00,000
85,00,000
Management Salaries
4,20,000
4,20,000
4,20,000
Rent and Taxes
2,80,000
2,80,000
2,80,000
3,50,000
3,50,000
3,50,000
Sundry office cost
4,45,000
4,45,000
4,45,000
14,95,000
14,95,000
14,95,000
(A) Sales
(B) Sales Cost
(1) Fixed Expenses
Budgetary Control
467
60%
capacity
Rs.
80%
capacity
Rs.
100%
capacity
Rs.
Plant Maintenance
1,25,000
1,37,500
1,43,750
Indirect Labour
4,95,000
5,44,500
5,69,250
Salesmens Salary and Expenses
1,45,000
1,59,500
1,66,750
Sundry Expenses
1,30,000
1,43,000
1,49,500
8,95,000
9,84,500
10,29,250
Material
14,40,000
19,20,000
24,00,000
Labour
15,36,000
20,48,000
25,60,000
2,28,000
3,04,000
3,80,000
32,04,000
42,72,000
53,40,000
55,94,000
67,51,500
78,64,250
(4,94,000)
48,500
6,35,750
(2) Semi Variable Expenses
(3) Variable Expenses
Total Sales Cost 1 + 2 + 3

(C) Profit A - B
(15) Based on sales foreast for the season, C Ltd. has prepared the following production
scheme for the coming month.
30,000 units of Product A and 20,000 units of product B. the manufacturing specifications
for the products are as follows.
Product A
Product B
2 Kgs. Material X @ Rs. 3
3 Kgs. Material W Rs. 8
1/2 Kg. Material Y @ Rs. 2
3/4 Kg. Material Y @ Rs. 2
2 hours direct labour @ Rs. 20
11/2 hours direct labour @ Rs. 20
To the direct labour hours, a 5% allowance for idleness (accounted for as overheads) should
be added. Indirect labour time is estimated to be 5% of direct labour hours (excluding idleness)
and the wage rate for indirect labour is Rs. 15. The overhead estimate (not shown above) is as
follows
Fixed Cost per month
Depreciation
Rs.
69,000
Insurance
Rs.
8,000
Superintendence
Rs.
30,000
Rs. 1,07,000
468
Variable Costs :
Rs 8 per direct labour hour.
Note : This rate includes the cost of idle lime and indirect labour.
It is planned to increase the inventory of raw material X by 4,000 Kgs and to decrease the
inventory of raw material W by 2,000 Kgs. as of the begining after next month.
You are required to prepare and estimate of the amount of cash necessary for manufacturing
operations of the coming month.
Assume that the materials and wages cost are paid in the month of purchase.
Solution :
Computation of Requirement of Cash
(A) For Raw Material : (Both Products A & B)
Rs.
X - 60,000 Kgs @ Rs. 3
1,80,000
Y - 30,000 Kgs @ Rs. 2
60,000
W - 60,000 Kgs @ Rs. 8
Rs.
4,80,000
7,20,000
Add : Increase in stock of X 4,000 kgs @ Rs. 3
12,000
7,32,000
Less : Decrease in stock of W 2,000 Kgs @ Rs. 8
16,000
7,16,000
(B) For Direct Wages

Product A - 60,000 hours @ Rs. 20
12,00,000
Product B - 30,000 hours @ Rs. 20
6,00,000
18,00,000
(C ) For Overheads
(1)
Idle Time - 5% of 90,000 hours i.e.

4,500 hours @ Rs. 20
(2)
90,000
Indirect Labour - 5% of 90,000 hours i.e.

4,500 hours @ Rs. 15
67,500
(3)
Variable Costs - 90,000 hours @ Rs. 8
7,20,000
(4)
Fixed Overheads
1,07,000
9,84,500
35,00,500
Budgetary Control
469
(16) A company is at present working at 90% of its capacity and producing 13,500 units perannum. It operates a flexible budgetary control system. The following figures (excluding
material and labour cost) are obtained from its budget :
90%
100%
(a)
Sales
Rs.
15,00,000
16,00,000
(b)
Fixed Expenses
Rs.
3,00,500
3,00,500
(c)
Semi-Fixed Expenses
Rs.
97,500
1,00,500
(d)
Semi-Variable Expenses
Rs.
1,42,000
1,49,500
Material and Labour Cost per unit are constant under present conditions. Profit margin is
10% at 90% capacity :
(a)
You are required to determine the cost of producing an additional 1,500 units.
(b)
What would you recommend for an export price for these 1,500 units taking into
account that overseas prices are much lower than indigenous prices?
Solution :
Cost Sheet
90% Capacity
100% Capacity
8,10,000
9,00,000
27,000
30,000
67,500
75,000
9,04,500
10,05,000
3,00,500
3,00,500
70,500
70,500
74,500
74,500
Variable Cost
Material / Labour
Variable portion of
Semi-Fixed Expenses
Variable portion of
a.
Total Variable Cost

Fixed Cost
Fixed Expenses
Fixed portion of
Semi-Fixed Expenses
Fixed portion of
470
b.
Total Fixed Cost
4,45,500
4,45,500
c.
Total Cost (a+b)
13,50,000
14,50,500
d.
Profit
1,50,000
1,49,500
e.
Sales
15,00,000
16,00,000
Hence, the cost of producing 1,500 units will be Rs. 1,00,500 i.e. Rs. 14,50,500
less Rs. 13,50,000. Recommended export price for these 1,500 units will be Rs. 67 i.e.
Rs. 1,00,500 / 1,500.
Working Notes :
a.
Semi-Fixed Expenses
With every 10% capacity increase, semi-fixed expenses increase by Rs. 3,000. This
means that variable portion of semi-fixed expenses is Rs. 3,000 for 10% capacity. For
90% capacity it will be Rs. 27,000 and for 100% capacity, it will be Rs. 30,000.
b.
With every 10% capacity increase, semi-variable expenses increase by Rs. 7,500. This
means that variable portion of semi-fixed expenses is Rs. 7,500 for 10% capacity. For
90% capacity it will be Rs. 67,500 and for 100% capacity, it will be Rs. 75,000.
(17) Develope the proforma (estimated) income statement for the months of October, November
and December of Ajax Lunatics Ltd. from the following information.
(a)
Sales are projected at Rs. 2,50,000, Rs. 3,00,000 and Rs. 2,00,000 for October,
November and December respectively.
(b)
Cost of goods sold is Rs. 75,000 plus 20% of sales per month.
(c)
Selling Expenses are 3% of sales.
(d)
Rent is Rs. 7,500 per month. Administrative Expenses is 15% of sales per month.
(e)
The company has Rs. 3,00,000 at 10% loan-The interest is payable monthly.
(f)
Corporate tax rate is 60%
Solution :
Proforma (Estimated) Income Statement of Ajax Lunatics Limited.
October
November
December
(A) Sales
2,50,000
3,00,000
2,00,000
(B) Cost
Cost of goods sold
1,37,500
1,50,000
1,25,000
Selling Expenses
7,500
9,000
6,000
Rent
7,500
7,500
7,500
37,500
45,000
30,000
2,500
2,500
2,500
1,92,500
2,14,000
1,71,000
(C ) Profit before tax (A - B)
57,500
86,000
29,000
(D) Income Tax - 60% of C
34,500
51,600
17,400
(E) Profit after tax (C - D)
23,000
34,400
11,600
Administretive Expenses
Interest on Loan
Total Cost
Budgetary Control
471
(18) M/s. Agarval fabricating and Manufacturing Co. Ltd. is presently working at 50% capacity,
producing and selling, 1,000 units of a product. You are required to find out the profits the
concern will make by working at 60% and 80% capacity.
At 50% capacity, the selling price is Rs. 200 per unit. Whereas the product cost is
Rs. 160 as given below.
Rs.
Materials Cost
80
Direct wages
30
Factory overheads
30 (of which 60% is variable)
Selling and Admn. overheads
20 (of which 50% is fixed).
At 60% capacity, material prices go up by 10% and selling price reduced by 5%.
At 80% capacity, there is increase in labour cost by 10% and variable factory overheads
go up by Rs. 2 per unit. The variable selling and administration overheads increase by
Re. I per unit, the other costs and selling price remain unchanged as at 60%.
Flexible Budget
(A) Number of units sold
50%
Capacity
60%
Capacity
80%
Capacity
1,000
1,200
1,600
Rs.
200
190
190
Sales
Rs.
2,00,000
2,28,000
3,04,000
(1) Materials Cost
80,000
1,05,600
1,40,800
(2) Direct Wages
30,000
36,000
52,800
Factory
18,000
21,600
32,000
Selling & Administration
10,000
12,000
17,600
Factory
12,000
12,000
12,000
Selling & Administration
10,000
10,000
10,000
1,60,000
1,97,200
2,65,200
40,000
30,800
38,800
(B) Cost
Rs.
(3) Variable Overheads
(4) Fixed Overheads
Total Cost
(C) Profit i.e. A - B
472
QUESTIONS
1.
What do you mean by Budget and Budgetary Control? What are the advantages of
Budgetary Control as a cost control technique? What are the prerequisites for the
successful implementation of Budgetary Control System?
2.
What is the meaning of Budget and Budgetary Control. State and explain various budgets
which can be established in the following functional areas of operation -
3.
a)
Sales/Marketing
b)
Production
c)
Finance
Write short notes on a)
Budget Manual
b)
Fixed and Flexible Budgets
c)
Cash Budget
Budgetary Control
473
PROBLEMS
(1)
The sales manager of a manufacturing company expects to sell 25,000 units of a certain
product.
The production director provides the following information. Two kinds of raw materials X
and Y are required for each unit of final product and 2 units of X and 3 units of Y are
required for one unit of final product. The estimated opening balance at the commencement
of next year areFinal product
- 5,000 units
- 6,500 units
- 8,000 units
The desirable closing balance at the end of next year are Final Product
- 7,000 units
- 6,500 units
- 8,000 units
Draw the production budget for the next year.
(2)
A Ltd. manufactures two products X and Y making the use of following raw materials in
the proportion shown.
Raw material
Product X
Rl
80%
R2
20%
Product Y
R3
50%
R4
50%
The finished weight of products X and Y are equal in weight of their ingredients. During a
month, it is expected that 1200 kgs. of X and 4000 kgs of Y will be sold.
474
Actual and budgeted inventories for the month are as below.

Material Actual
Opening Stock
Budgeted Closing Stock
Kgs.
Kgs.
R1
300
400
R2
200
800
R3
4000
6000
R4
5000
4000
200
100
1000
1200
The purchase price of materials is expected to be as below.

Cost Per Kg.
Rs.
R1
50
R2
40
R3
10
R4
20
All materials will be purchased on 1st of the month.

Prepare -(a) Production Budget.
(b) Purchases Budget.
(3)
A Ltd. produces a standard product. The estimated cost per unit in given below.
Rs.
Raw materials
10
Direct wages
Direct Expenses
Variable Overhead
Fixed overheads are estimated to Rs. 70,000 selling price per umt is Rs. 40. Prepare a
flexible budget at 50%, 70% and 90% level of activity. Assume that output at 100% level
of activity is 10,000 units.
Budgetary Control
475
(4)
The following expenses relate to a cost centre operating at 80% of normal capacity
(Sales are Rs.1,20,000) Draw up flexible Administration, Selling and Distribution costs
budget operating at 90%, 100% and 110% of normal capacity.
Administration Costs
Office Salaries
Rs. 3,000
General Expenses
1.5% of sales
Depreciation
Rs. 1,500
Rates and Taxes
Rs. 1,750
Selling Costs
Salaries
4% of sales
Travelling Expenses
1.5% of sales
Sales Office Expenses
1% of sales
General Expenses
1% of sales
Distribution Costs
Wages
Rent
Other Expenses
(5)
Rs.3,000
0.5% of sales
2% of sales
The expenses budgeted for production of 10,000 units in a factory are furnished below.
Per Unit
Rs.
Materials
70
Labour
25
Variable Overheads
20
Fixed Overheads ( Rs.1,00,000)
10
Variable Expenses (Direct)

Selling Expenses (10% Fixed)
5
13
Distribution Expenses (20% Fixed)
Adinimstrative Expenses (Rs.50,000)
Total Cost of sale per unit
155
(to make and sale)

Prepare a budget for the production of
a. 8,000 units and b. 6,000 units.
476
Assume that administrative expenses are rigid for all levels of production.
(6)
Following are the actuals for the year 1985.

Rs.
Sales 20,000 units @ Rs.3 per unit
60,000
Raw Material
26,500
Direct Labour Cost
5,000
Variable Overheads
8,000
Fixed Overheads
10,000
The management expects following estimate in 1986. Sales to increase to 30,000 units,
selling price remaining unchanged. Raw materials prices increase by 10%, wage rate to
increase by 10% but labour productivity improves by 5%.
Fixed overheads are expected to increase by Rs. 2,000. You are required to prepare the
budget for 1986.
(7)
Production costs of a factory for a year are as follows.

Direct Wages
Direct Materials
Rs. 90,000
Rs. 1,20,000
Production Overheads :
Fixed
Rs. 40,000
Variable
Rs. 60,000
During the forthcoming year, it is anticipated that :

(a)
The average rate for direct labour remuneration will fall from 90 paise to 75 paise per
hour.
(b)
Production efficiency will be reduced by 5%.
(c)
Price per unit of direct material and other materials and services which comprise
overheads will remain unchanged and
(d)
Direct labour hours will increase by 33 1/3.
Draw up a budget and compute a factory overhead rate, the overheads being absorbed
on a direct wages.
(8)
ABC Ltd. manufacturing a single product is facing a severe competition in selling at

Rs. 50 per unit. The company is operating at 60% level of activity at which level sales are
Rs. 12,00,000. Variable costs are Rs.30 per unit. Semi variable costs may be considered
Budgetary Control
477
as fixed at Rs. 90,000 when output is nil and variable element is Rs.250 for each additional
1% level of activity. Fixed costs are Rs, 1,50,000 at the present level of activity, but at the
level of activity of 80% or above if reached, these costs are expected to increase by
Rs.5,000.
To cope with the competition, the management of the company is considering a proposal
to reduce the selling price by 5%. You are required to :
(9)
(a)
Prepare a statement showing the operating profit at levels of activity of 60%, 70%
and 80%. Assuming that the selling price remains at Rs.50 per unit.
(b)
If selling price is reduced by 5%, show the number of units which will be required to
be sold to maintain the present profits.
A company, producing electronic watches, estimates the following factory overheads

costs for producing 5,000 Units
Indirect Materials
Rs. 16,000
Indirect Labour
Rs. 30,000
Inspection Cost
Rs. 16,000
Heat, light & power
Rs. 8,000
Expendable tools
Rs. 8,000
Supervision Costs
Rs. 8,000
Equipment depreciation
Rs. 4,000
Factory Rent
Rs. 4,000
Indirect labour, indirect material and expendable tools are entirely variable. Heat, light
and power and inspection costs are variable to the extent of 50% and 40% respectively.
Other costs are fixed costs for a month. Prepare a flexible budget for overheads for
production of 4,000 and 6,000 units per month. Also find out the average factory overheads
per unit for these two production levels.
(10) Anil and Avinash Enterprises is currently working at 50% capacity and produces 10,000
units. Estimate the profits of the company when it works at 60% and 70% capacity.
At 60% capacity, the raw materials cost increases by 2% and the selling price falls
by 3%. At 70% capacity the raw materials cost increases by 4% and selling price falls
by 5%.
At 50% capacity, the product costs Rs. 180 per unit and is sold for Rs.200 per unit.
478
The unit cost of Rs. 180 is made up as below.

Materials cost
Rs. 100
Wages
Rs. 30
Factory overheads
Rs. 20 (40% Fixed)
Administration overheads
Rs. 30 (50% fixed)
(11) ABC Ltd. manufactures a single product for which market demand exists for additional
quantity. Present sale of Rs. 60,000 per month utilities only 60% capacity of the plant.
Sales Manager assures that with a reduction of 10% in the price, he would be in a
position to increase the sale by about 25% to 30% .
The following data are available.
(a)
Selling price
- Rs. 10 per unit
(b)
Variable cost
- Rs. 3 per unit
(c)
Semi-variable cost
- Rs. 6,000 plus Rs.0.50 per unit
(d)
Fixed coct -
Rs. 20,000 at present level, estimated to be Rs.24,000

at 80% output.
You are required to submit the following statements to the Board showing.
(1)
The operating profits at 60%, 70% and 80% levels at current selling price and at
proposed selling price.
(2)
The percentage increase in the present output which will be required to maintain
the present profit margin at the proposed selling price.
(12) A manufacturing company has an installed capacity of 1,20,000 units per annum. The
cost structure of the products manufactured is as under :
(i)
Variable Cost ( Per Unit)

Materials
Rs. 8
Labour
Rs. 8
(Subject to a minimum of Rs.56,000 per month)

Overheads
(ii)
Rs. 3
Fixed overheads are Rs. 1,04,000 per annum.
(iii) Semi variable overheads Rs.48,000 per annum at 60% capacity, which will increase
by Rs.6000 per annum for increase of every 10% of the capacity utilization or any
part thereof.
Budgetary Control
479
The capacity utilization for the next year is estimated at 60% for 2 months, 75% for 6
months and 80% for the balance part of the year. If the company is planning to have a
profit of 25% on the selling price, calculate the estimated selling price for each unit of
production. Assume there is no opening or closing stock.
(13) The monthly budgets for manufacturing overhead of a concern for two levels of activity
were as follows Capacity
60%
100%
600
1000
(Rs.)
(Rs.)
1,200
2,000
900
1,500
Maintenance
1,100
1,500
Power and Fuel
1,600
2,000
Depreciation
4,000
4,000
Insurance
1,000
1,000
9,800
12,000
Budgeted Production (units)

Wages
Consumable Stores
Indicate which of the items are fixed, variable and semi-variable.
b.
Prepare a budget for 80% capacity.
c.
Find out the total cost, both fixed and variable, per unit of output at 60%, 80% and
100% capacity.
(14) From the following data, prepare a flexible budget for the production of 40,000 units,
60,000 units and 75,000 units, distinctly showing variable and fixed costs as well as
total costs. Also indicate element wise cost per unit.
Budgeted output and budgeted cost per unit
Budgeted output
100000 units
Per unit cost Rs.
480
Direct Material
90
Direct Labour
45
Direct Variable Expenses
10
Manufacturing Variable Overheads
40
Fixed Production Overheads
Administration Overheads (Fixed)
Selling Overheads
10 (10% fixed)
Distribution Overheads
15 (20% fixed)
(15) The budget manager of Progressive Electrical Limited, is preparing a flexible budget for
the accounting year commencing 1st April 1995. The company produces one product a component - Kaypee. Direct Material costs Rs. 7 per unit. Direct Labour averages
Rs. 2.50 per hour and requires 1.60 hours to produce one unit of Kaypee. Salesmen are
paid a commission of Re. 1 per unit sold. Fixed selling and administration expenses
amount to Rs. 85,000 per year.
Manufacturing overheads under specified conditions of volume have been estimated as
follows Volume of Production (units)
1,20,000
1,50,000
Rs.
Rs.
Indirect Materials
2,64,000
3,30,000
Indirect Labour
1,50,000
1,87,500
Inspection
90,000
1,12,500
Maintenance
84,000
1,02,000
1,98,000
2,34,000
Depreciation
90,000
90,000
Engineering Services
94,000
94,000
9,70,000
11,50,000
Supervision
Total Manufacturing Overheads
Normal capacity of production of the company is 1,25,000 units. Prepare a budget of

total cost at 1,40,000 units of output.
(16) Excellent Manufacturers can produce 4000 units of a certain product at 100% capacity.
The following information is obtained from the books of accounts -
Units produced
Power
Shop Labour
Consumable Stores
Salaries
Inspection
Depreciation
June 94
2,800
Rs.
500
1,800
700
1,400
1,000
200
1,400
July 94
3,600
Rs.
560
2,000
900
1,800
1,000
240
1,400
The rate of production is 10 units per hour. Direct Materials cost is Re. 1 and Direct
Wages per hour is Rs. 4. You are required to -
Budgetary Control
481
a.
Compute the cost of production at 100%, 80% and 60% capacity showing the
variable, fixed and semi-fixed items under the flexible budget.
b.
Find out the overhead absorption rate per unit at 80% capacity.
(17) The following data are available for a manufacturing company for a yearly period Rs. in Lakhs
Fixed Expenses - Wages and Salaries
9 .5
- Rent, Rates and Taxes
6.6
- Depreciation
7.4
- Sundry Administrative Expenses

Semi-Variable Expenses (at 50% capacity)
6 .5
- Maintenance and Repairs
3 .5
- Indirect Labour
7 .9
- Sales Department Salaries
3 .8
- Sundry Administrative Salaries

Variable Expenses (at 50% capacity)
2.8
- Material
21.7
- Labour
20.4
- Other Expenses
7.9
98.0
Assume that the fixed expenses remain constant at all levels of production, semi-variable
expenses remain constant between 45% and 65% of capacity increasing by 10% between
65% and 80% capacity and by 20% between 80% and 100% capacity.
Sales at various levels are Rs. in Lakhs
50% capacity
100
60% capacity
120
75% capacity
150
90% capacity
180
100% capacity
200
Prepare a flexible budget for the year at 60% and 90% capacities and estimate the
profits at these levels of output.
482
(18) A factory is currently running at 50% capacity and produces 5,000 units at a cost of
Rs. 90/- per unit as per details below :
Rs.
Material
50
Labour
15
Factory overheads
15 (Rs. 6/- fixed)
Administrative overheads
10 (Rs. 5/- fixed)
The current selling price is Rs. 100/- per unit.

At 60% working, material cost per unit increases by 2% and selling price per unit falls
by 2%.
At 80% working, material cost per unit increases by 5% and selling price per unit falls
by 5%.
Estimate profits of the factory at 60% and 80% working and offer your comments.
(19) On 30th September 1990, the Balance Sheet of Melodies Pvt. Ltd. retailers of musical
instruments, was as under Liabilities
Rs.
Ordinary shares of Rs.10
Assets
Rs.
Equipment (at cost)
20,000
Less : Depreciation
5,000
each fully paid
20,000
Reserves and surplus
10,000
Trade Creditors
40,000
Stock
20,000
Proposal Dividend
15,000
Trade Debtors
15,000
Balance at Bank
35,000
15,000
85,000
85,000
The company is developing a system of forward planning and on 1st October 1990, it
supplies the following information.
Credit Sales
Rs.
Cash Sales
Rs.
Credit Purchases
Rs.
Sept. 90 (Actual)
15,000
14,000
40,000
Oct. 90 (Budget)
18,000
5,000
23,000
Nov. 90 (Budget)
20,000
6,000
27,000
Dec. 90 (Budget)
25,000
8,000
26,000
All trade debtors are allowed one months credit and are expected to settle promptly. All
trade creditors are paid in the month following delivery.
Budgetary Control
483
On 1st October 1990, all the equipment was replaced at a cost of Rs. 30,000.
Rs. 14,000 was allowed in exchange for the old equipment and a net payment of
Rs. 16,000 was made. Depreciation is to be allowed at the rate of 10% per annnm. The
proposed dividend will be paid in December 1990.
The following expenses will be paidWages Rs. 3,000 per month.
Administration Rs. 1500 per month.
Rent Rs. 3600 for the year to 30th September 1991 (to be paid in October, 1990)
The gross profit percentage on sales is estimated at 25%.
You are required (1)
To prepare cash budget for the months of October, November and December.
(2)
To prepare Income Statement for the three months ended 31st December 1990.
(20) Develop Performa income statement for the months of July, August and September for a
company for the following information.
(a)
Sales are projected at Rs. 2,25,000, Rs. 2,40,000 and Rs. 2,15,000 for July, August
and September respectively.
(b)
Cost of goods sold is Rs.50,000 plus 30% of selling price per month.
(c)
Selling Expenses are 3% of sales.
(d)
Rent is Rs. 7,500 per month, administrative expenses for July are expected to be
Rs. 60,000 but are expected to rise 1% per month over the previous months
expenses.
(e)
The company has Rs.3,00,000 of 8% loan interest payable monthly.
(f)
Corporate Tax rate is 70%.
(21) The projected sales and purchases of ABC Ltd. for the months July to November 1983
are
484
Sales (Rs.)
Purchases (Rs.)
July
6,20,000
3,80,000
August
6,40,000
3,33,000
September
5,80,000
3,50,000
October
5,60,000
3,90,000
November
6,00,000
3,40,000
The wages are expected to be Rs.100,000 per month. The management is expected to
pay two months wages as bonus during October 1983. The company is expected to pay
advance income tax Rs. 90,000 before 15th September 1983. The company has ordered
in June 1983 for a machine costing Rs. 16,00,000. The Bank has agreed to finance the
purchase of the machine which is expected to be delivered in January 1984. The company
has advanced 5% in June 1983 and they have agreed to pay another 10% advance after
3 months. The company extends 2 months credit for the customers and enjoys one
month credit from the suppliers. The general expenses for the company is Rs.60,000 per
month payable at the end of each month. The company anticipates to receive dividends
of 10% for the investments of 90,000 shares of Rs. 10 each during October 1983.
The company anticipates to have an overdraft of Rs. 40,000 on 1st September 1983
(limit sanctioned is Rs. 55,000). Draw a cash budget for September 83 to November 83
for approaching bankers for a short term further credit.
(22) From the following budgeted data of ABC Ltd., prepare cash budget for the quarter
ending 31st December 1984.
Month
Sales
Purchases
Wages
Misc. Exp.
August
1,20,000
84,000
10,000
7,000
September
1,30,000
1,00,000
12,000
8,000
80,000
1,04,000
8,000
6,000
November
1,16,000
1,06,000
10,000
12,000
December
88,000
80,000
8,000
6,000
October
Additional information :
Cash on hand on 1,10.84 Rs. 5,000
Sales 20% realised in the month of sale. Discount allowed 2%. Balance realised in
subsequent month.
Purchases - These are paid in the following the month of supply.
Wages - 25% in arrears paid in the following month.
Misc. Expenses - Paid a month in arrears.
Rent - Rs.1,000 per month paid quarterly in advance, due in October.
Income Tax - Instalments of Rs. 25,000 due on or before 15.12 84.
Income from investment - Rs. 5,000 received quarterly April, July, October etc.
Insurance claim - Rs. 72,936 receivable in December.
Budgetary Control
485
(23) A firm expects to have to Rs. 30,000 in Bank on 1.10.86 and requires you to prepare an
estimate of cash position during the three months October 86 to December 86. The
following information is supplied to you.
Month
Sales Purchases
Wages
Rs.
Rs.
Rs.
Factory
Exp.
Rs.
Office
Exp.
Rs.
Selling
Exp.
Rs.
August
40,000
24,000
6,000
3,000
4,000
3,000
September
46,000
28,000
6,500
3,500
4,000
3,500
October
50,000
32,000
6,500
4,000
4,000
3,500
November
72,000
36,000
7,000
4,000
4,000
4,000
December
84,000
40,000
7,250
4,250
4,000
4,000
Other information :
(1)
25% of the sales are for cash, remaining amount in the month following that of sale.
(2)
Suppliers supply goods at 2 months credit.
(3)
Delay in the payment of wages and all other expenses one month.
(4)
Income Tax of Rs.l0,000 is due to be paid in December.
(5)
Preference shares dividend of 10% on Rs.l ,00,000 is to be paid in October.
(24) Mr. Ashok Kumar, the Finance Manager of Mazumdar Castings Ltd. is preparing the
cash budget for the first six months of 1982, on the basis of the following information :
(i)
Costs and Price remains unchanged.
(ii)
Out of the total sales, cash sales are 25%, the balance being credit sales. 60% of
the credit sales are collected in the month after sales, 30% are collected in the
second month, and the balance 10% in the third month after sale. He does not
expect any bad debts.
(iii) The Gross Profit Margin is expected to be 20%

(iv)
486
Actual sales and forecast sales are as follows :

Oct. 81
Rs.
12,00,000
Mar. 82
Rs.
8,00,000
Nov. 81
Rs.
14,00.000
April 82
Rs.
12,00,000
Dec. 81
Rs.
16,00,000
May 82
Rs.
12,00,000
Jan. 82
Rs.
8,00,000
Jun. 82
Rs.
8,00,000
Feb. 82
Rs.
8,00,000
Jul. 82
Rs.
10,00,000
(v)
(vi)
Anticipated Cash Purchases, there being no Credit Purchases:

Jan 82
Rs.
6,40,000
April 82
Rs.
9,10,000
Feb. 82
Rs.
7,00,000
May 82
Rs.
6,40,000
Mar. 82
Rs.
10,00,000
Jun. 82
Rs.
9,60,000
Wages and salaries to be paid in cash :

Jan 82
Rs.
1,40,000
Feb. 82
Rs.
1,60,000
Mai. 82
Rs.
2,00,000
Apr. 82
Rs.
2,20,000
May 82
Rs.
1,60,000
Jun 82
Rs.
1,40,000
(vii) Interest on 20,00,000 8% Debentures was due on June 30, 1982 (half yearly)
(viii) Excise deposit due on March 31, 1982 Rs. 3,00,000.
(ix) Acquisition of plant and equipment planned for May 1982 Rs. 10,00,000.
(x)
Miscellaneous Expenses on a cash basis every month at Rs. 15,000 plus 10% of
sale.
(xi) The company will have a cash balance of Rs. 5,00,000 on 31.12,81. Mr. Ashok
Kumar believes that this is a high level and is planning on a continuous balance of
Rs. 4,00,000
(a)
Prepare the Cash budget for six months to June 1982 .
(b)
If additional finance is required, recommend the type of finance to be obtained.
(25) A company has its cost of goods of 70% of its sales, 70% of this cost is paid in the
month of the sale and the balance in the next month. Salary and administrative expenses
amount to Rs. 40,000 per month plus 5% of sales. These expenses must be paid during
the month following the month when expenses are actually incurred . The company has
also 10% Debentures of Rs. 1,50,000 and interest has to be paid in 4 quarters from
January onwards. The company gives its actual and forecast sales as below.
Actual Sales
Rs.
Forecast sales
Rs.
January
2,00,000
May
2,00,000
February
2,00,000
June
2,50,000
March
3.00,000
July
2,50,000
April
3,00,000
August
3,00,000
Budgetary Control
487
You are required to prepare a cash flow schedule for six months from March onwards.
(26) Following details are available in case of Pam Industries Ltd.
Actual Sales
Rs.
Estimated sales
Rs.
January
65,000
May
1,05,000
February
75,000
June
1.20,000
March
90,000
July
1,25,000
April
80,000
August
1,35,000
Consider the following additional information :

(1)
Cash sales are 50 per cent of the total sales. The remaining 50 per cent will be
collected equally during the following two months.
(2)
Cost of goods manufactured is 70 per cent of sales. 90 per cent of this cost is paid
during the first month after incurrence and the balance is paid in the following
month.
(3)
Sales and administrative expenses are Rs. 15,000 per month plus 10 per cent of
sales. All these expenses are paid during the month of incurrence.
(4)
Half- yearly interest of 6 per cent on Rs. 4,50,000 Debentures is paid during July.
(5)
Rs. 60,000 are expected to be invested in fixed assets during July.
(6)
A dividend of Rs. 15,000 will be paid in July.
(7)
An income tax of Rs. 15,000 will be paid in July.
It is the policy of the company to have a minimum cash balance of Rs. 30,000/-.
Accordingly as on 30th April, the actual cash balance was Rs. 30,000/-.
The Management wishes to know whether it will be required to borrow during the quarter
ending on 31st July and if so when and how much.
(27) Prepare a cash budget for the three months ending 30th June 1986 from the information
given below.
(a) Month
488
Sales Materials
Rs.
Rs.
Wages
Rs.
Overheads
Rs.
February
14,000
9,600
3,000
1,700
March
15,000
9,000
3,000
9,900
April
16,000
9,200
3,200
2,000
May
17,000
10,000
3,600
2,200
June
18,000
10,400
4,000
2,300
(b)
Credit terms are :

Sales/Debtors - 10% of sales are on cash, 50% of the credit sales are collected
next month and balance in the month following
Creditors -
Materials
- 2 months
Wages
- 1/4 month
Overheads
- 1/2 month
(c)
Cash and Bank balance on 1st April 1986 is expected to be Rs.6,000.
(d)
Other relevant information :
(i)
Plant and Machinery will be installed in February 1986 at a cost of Rs. 96,000. The
monthly instalments of Rs. 2,000 is payable from April onwards.
(ii)
Dividend @ 5% on preference share capital of Rs.2,00,000 will be paid on 1st June.
(iii) Advance to be received for sale of vehicle Rs. 9,000 in June.

(iv)
Dividends from investment amounting to Rs. 1,000 expected to be received in June
(v)
Income Tax advance is to be paid in June - Rs. 2,000.
(28) Prepare a cash budget of XYZ Ltd. on the basis of the six months commencing from
April 1989.
(1)
Cost and prices remain unchanged.
(2)
Cash sales are 25% of the total sales and balance 75% will be credit sales.
(3)
60% of credit sales are collected in the month following the sales, balance 30%
and 10% in the two following months thereafter. No bad debts are anticipated.
(4)
Sales forecasts are as follows - (Rs. in lakhs)

Jan. 89
- 12
Feb. 89
- 14
March 89
- 16
April 89
-6
May 89
-8
June 89
-8
July 89
- 12
August 89
- 10
Sept. 89
-8
Oct. 89
-12
(5)
Gross Profit margin 20%
(6)
Anticipated purchases - (Rs. in lakhs)

April 89
- 6.40
May 89
- 6.40
June 89
- 9.60
July 89
- 8.00
August 89
- 6.40
Sept. 89
- 9.60
Budgetary Control
489
(7)
Wages and Salaries to be paid - (Rs. in lakhs)

April 89
- 1.20
May 89
- 1.60
June 89
- 2.00
July 89
- 2.00
August 89
- 1.60
Sept. 89
- 1.40
(8)
Capital expenditure for plant and machinery planned for September 1989 is
Rs. 1,20,000.
(9)
Company has a cash balance of Rs. 4,00,000 as at 31st March, 1989 and will
maintain it in future also at minimum level.
(10) The Company can borrow on monthly basis.

(11) Rent is Rs. 8,000 per month.
(29) Lal and Company has given the forecast sales for January 1989 to July 1989 and actual
sales for November and December 1988 as under. With the other particulars given,
prepare a Cash Budget for the five months i.e. from January 1989 to May 1989.
(1)
Sales
November 88
1.60
Lakhs
April 89
2.00 Lakhs
December 88
1.40
Lakhs
May 89
1.80 Lakhs
January 89
1.60
Lakhs
June 89
2.40 Lakhs
February 89
2.00
Lakhs
July 89
2.00 Lakhs
March 89
1.60
Lakhs
(2)
Sales 20% cash and 80% credit, payable in the third month (January sales in
March).
(3)
Variable expenses 5% on turnover, time lag half month.
(4)
Commission 5% on credit sales payable in the third month.
(5)
Purchases being 60% of the sales of the third month, payment will be made on 3rd
month of purchases.
(6)
Rent and other expenses Rs. 6,000 paid every month.
(7)
Other Payments Fixed Assets Purchases - March Rs. 1,00,000

Taxes - April Rs. 40,000
(8)
490
Opening cash balance Rs. 50,000
NOTES
Budgetary Control
491
NOTES
492
Chapter 13
STANDARD COSTING
INTRODUCTION :
The determination of the actual cost on the basis of various costing records maintained is no
doubt important, but such actual cost (or historical cost) involves some limitations as to its
utility.
(1)
The actual cost information is available only after the completion of the job, process or
service and hence is of no practical utility from control point of view, as no basis is
provided with which the actual costs can be compared.
(2)
There are various kinds of managerial decisions where cost is an inevitable basis E.g.
price fixation or submission of quotations. However if the details of actual cost are available
too late, such cost details are of no practical utility for the purpose of price fixation or
submission of quotation.
(3)
The actual costs may be affected due to the inefficient functioning. The actual costs may
be excessive due to abnormal expenses, avoidable wastes, inefficient use of labour and
excessive use of materials. As such, actual costs are not useful for providing a yardstick
for measuring efficiency of performance.
(4)
Actual costing is comparatively expensive as it involves the maintenance of various

records and documents. The above stated limitations involved with the determination of
actual costs has given rise to the technique of standard costing.
CONCEPT OF STANDARD COST AND STANDARD COSTING :

The term standard cost has been defined as a pre-determined cost which is calculated from
the managements standards of efficient operation and the relevant necessary expenditure.
The term standard costing has been defined as the preparation and use of standard costs,
their comparison with actual costs and the measurement and analysis of variances to their
causes and points of incidence.
Standard Costing
493
Thus, standard cost is the normal cost under the ideal circumstances. It may be used as a
base for the purpose of price fixation and submission of quotations. Moreover, the standards
when compared with the actual cost may also be used as tools for cost control and as a
yardstick for measuring efficiency of performance, which is possible with standard costing
system. As such, the process of standard costing involves the following stages.
(1)
Predetermination of technical data related to production i.e. details of materials and

labour operations required for each product, the quantum of inevitable losses, level of
activity etc.
(2)
Predetermination of standard costs in full details under each element of cost i.e. Labour,
Material and Overhead.
(3)
Comparison of actual performance and costs with standards and working out the variances
i.e. the difference between the actual and the standards.
(4)
Analysis of variances in order to determine the reasons for deviations of actuals from the
standards.
(5)
Presentation of information to the appropriate level of management to enable suitable

action being taken, or revision of standards.
It should be noted in this connection that standard costing is not a separate system of
accounting but only a technique used with the intention of controlling the costs. Though it can
be used in case of all methods of costing like job costing, process costing etc.; it can be more
effective in case industries producing the standard products on continuous basis.
Advantages of standard costing :
494
(1)
Standard costing provides a yardstick with reference to which the efficiency/inefficiency

in performance may be established. This facilitates the basic management function of
cost control.
(2)
Standard costing provides the incentive and motivation to work with greater effort for
achieving the standard.
(3)
Standard costs may be used as the basis for the process of price fixation, filing the
tenders and offering the quotations. If the prices are to be quoted on cost plus basis,
actual costs may not be available in which case standard costs can be the base for
fixation of selling prices.
(4)
Standard costing system facilitates delegation of authority and fixation of responsibility

for each individual or department. This also tones up the general organization of the
concern.
(5)
Variance analysis and reporting is based on the principle of management by exception.

The top management may not be interested in details of actual performances but only in
the variations from the standard, so that corrective measures may be taken in time.
(6)
When constantly reviewed, the standards provide means for and encourage action for
cost reduction. Focus on out of control situations, leads to cost reduction through the
improved methods, improved quality of products, better material and workers, effective
selection and use of capital resource etc.
(7)
A properly laid down system of standard costing may facilitate the correct implementation
of the technique of budgetary control which also is a good system of cost control.
Limitations of standard costing :

(1)
Establishment of standard costs is difficult in practice. Even though, standards are fixed
after defining properly, there is no guarantee that the standards established will have the
same tightness or looseness as envisaged.
(2)
In the course of time, even in a short period, the standards become rigid. It may not be
possible to maintain the standards to keep pace with the changes in manufacturing
conditions. Revision of standards is costly.
(3)
Sometimes, standards set create adverse effects. If standards are set tightly and there
is non-achievement of the same, it creates frustration.
(4)
The standard costing may not be suitable in all types of organizations e.g.
(i)
In case of small concerns- Where the production cannot be properly scheduled. In

small concerns, personal contacts may be more effective than the standard costing.
(ii)
In case of industries having non-standardized products.
(iii) In case of industries having repair jobs which keep changing as per customer
requirements.
(iv)
In case of industries where products take more than one accounting period to
complete e.g. contract jobs.
(5)
Due to the play of random factors, it may be difficult to properly examine the variance
and distinguish between controllable and uncontrollable variances. e.g. Adverse labour
time variance may be due to poor grade of labour, poor quality of material, defective plant
and machinery and lack of trained workers.
(6)
Lack of interest in standard costing on the part of the management makes the system
ineffective and cant be used as a proper means of cost control.
Standard Costing
495
Standard costing and budgetary control compared :

Both standard costing and budgetary control are the best possible tools available to the
management for the purpose of controlling the costs. Both the techniques involve the process
of setting the targets or standards, measurement of actual performance, comparison of actual
performance with targets or standard set, computation and analysis of variations and the
attempts to maintain favorable variations and remove unfavorable variations. The technique of
budgetary control can be used effectively if the system of standard costing is prevailing. Thus,
both the techniques complement each other but are not necessary dependent upon each
other. On the other hand, in spite of the various similarities, both the techniques differ from
each other in certain respects.
(1)
System of budgetary control may be operated even if no standard costing system is in

use in the concern.
(2)
Budgets are the ceilings or limits on expenses above which actual expenditure should
not normally exceed and if it does, the planned profits will be reduced. Standard costs
are minimum targets to be attained by the actual performance.
(3)
Budgets may be prepared in the various areas of activities like sales, production,
purchases, capital investment etc. Whereas standard costing specifically relates to the
function of production and manufacturing costs.
(4)
A more searching analysis is required to be made in case of standard costing variances

than in case of budgetory control variances. Variances in case of budgets may point out
efficiency or inefficiency. But variances in case of standard costing provide material for
further probe and investigation.
(5)
The scope of standard costing is much wide than that of budgetary control. Adherence
to budgeted performance may indicate that the business is out of difficulties. A genuine
attempt to attain the standards always provides the scope for improved performance.
(6)
Budgets are based upon the future or estimated costs which may be used for forecasting
the requirements of various factors of production like material, labour, finance etc. Standard
costs are planned or ideal costs under the ideal situations as to operating efficiency,
capacity level attainment and so on. Standard costs may not be necessarily useful for
forecasting purposes.
Preliminaries for Establishing Standard Costing System :

Before the standard costing system is established in an organization, the following preliminaries
will have to be complied with.
496
(1)
Establishment of cost centres :

As explained before, a cost centre is any unit with respect to which the costs will be
ascertained. If the standard costing system is to be implemented, the cost centres
should be defined very clearly so that the responsibility can be fixed in case of non
standard performance.
(2)
Design of Accounts :
As the standard costing essentially involves the process of comparing the actual
performance to standard performance and computation of variances therefrom, the
accounts should be designed in such a way that the information about the actual
performance is available as correctly as possible and as speedily as possible. For this
purpose, the codification of accounts may be considered.
(3)
Establishment of standards :
This is probably the most critical part of the implementation of standard costing i.e. to
establish the standards with respect to the individual elements of cost i.e. Direct Material
Cost, Direct Labour Cost and Overheads. It is necessary to exercise maximum care
while establishing the standards as wrongly established standards may defeat the purpose
of standard costing.
Following steps are involved in the process of establishing the standards.

(a)
Study of technical and operational details of the organization like the manufacturing
process, levels of managements and their responsibilities, units and nature of inputs and
outputs, details regarding wastes and losses, expected efficiency and capacity utilization
etc.
(b)
Study of existing cost accounting systems and formats in use.
(c)
Decision about the types of standards to be used. It may be noted that there may be
various types of standards.
Basic Standards :
These are established for an unaltered use over a longer period of time and they dont reflect
the current conditions. These types of standards are not useful from the cost control point of
view and can be used in case of industries where technical processes are fully established or
in case of those types of costs which are fixed in nature viz. rent, remuneration to managerial
personnel etc.
Standard Costing
497
Current Standards :
These are established for a shorter period of time and are adaptable to change in current
conditions. As current conditions are likely to change, the current standards are also subject
to revision as per the changes in current conditions.
Current standards may be of three types.
Ideal Standards :
These are the standards which are set which are attainable under the most favourable conditions
possible and assumes the maximum utilization of various factors of production (like men,
material and machines) which is not practicable and attainable. Thus, the ideal standards are
generally theoretical in nature and the variances always show an unfavorable trend. The basic
limitation of these types of standards is that the constant non achievement of these standards
causes frustration among the staff and the constant reporting of unfavorable variances is
presumed which results into lost impact of system itself.
Expected Standards :
These are the standards which are anticipated to be attained during the budget period. These
are based upon the expected performance based upon the conditions which are likely to
prevail during the budget period. Allowances are provided for the unavoidable deviations from
the ideal performance e.g. Labour time wastage, excess material use, break down of machinery
etc. Thus, these standards are more realistic in nature and are more useful from cost control
point of view.
Normal Standards :
These are the standards which may be anticipated to be achieved in future, over a longer
period of time, considering the past performance. As such, the inefficiencies of the past
performance, if any, get reflected in these types of standards. Further, the problems faced in
estimating the future over a longer period of time also restrict the use of these standards for
cost control purposes.
After the consideration of various types of standards which may be used, the process of
establishment of standards with respect to various elements of costs comes into operation.
As discussed above, the standards may be set for the various elements of costs i.e. Direct
Material Cost, Direct Labour Cost and Overheads.
(a)
Direct Material Cost :

Setting the Standard Cost for Direct Material, involves two stages i.e. To decide Price
Standard and to decide Use Standard.
498
Price Standard :
It may involve the consideration of following factors.
(i)
Current market conditions and likely changes.
(ii)
Prices of current supply orders.
(iii) Prices of long term supply contracts.

Along with the basic prices, it may involve the consideration of the factors like discount,
packing charges, insurance, sales tax, octroi etc. It may be the primary responsibility of the
Purchase Department to supply the details required for this purpose.
Use Standard :
It may be the primary responsibility of Engineering or Design Department to supply the details
required for this purpose, on the basis of standard bill of material.This may involve the process
of product study. Sufficient provisions should be made for unavoidable scrap or wastages.
(b)
Direct Labour Cost :

Setting the standard cost for Direct Labour involves two stages i.e. To decide the wage
rate standard and to decide Labour Efficiency standard.
Wage Rate Standards :

It may involve the consideration of following factors.
(i)
The system of wages payments prevailing i.e. Piece Rate Wages or Time Rate Wages
(ii)
Systems prevailing for bonus payments
(iii) The provisions of agreements with workers covering a future period of time.
(iv)
Provisions of various laws and guidelines governing the fixation of wage rates
(v)
Grades of workers required and likely trends of market conditions in respect of availability
thereof.
Labour Efficiency Standards :

It may be decided on the basis of the consideration of following factors.
(i)
Records of past performance.
(ii)
Time and motion study considering the details in respect of an average worker as the
base.
Standard Costing
499
(iii) Trial Runs, specifically in respect of a new product. Sufficient provision should be made
in respect of the unavoidable idle time.
(c)
Overheads Cost :
Setting the standard cost of overheads involves the following stages.
(i)
Estimation of standard overheads cost.
(ii)
Estimation of standard level of activity ( in terms of labour hours, machine hours or

units of production)
(iii) Estimation of standard overhead absorption rate which may be decided as below.
Standard Overhead Cost
Standard Level of Activity
Thus, the standard absorption rate may be per unit of production, per labour hour or per
machine hour.
For better control purposes, the standards for overhead cost may be decided separately for
fixed overheads and variable overheads, as fixed overbeads are normally uncontrollable at the
lower level of management.
(4)
Reporting of Variances :
The basic intention of implementation of standard costing system as a cost control
device is not complete till the variances computed in respect of each element of cost are
properly reported to the relevant level of management for the decision making purposes.
For this purpose, the following propositions should be considered.
500
(a)
For effective cost control, the organizational structure should be clearly defined and
responsibility of each individual should be clearly defined.
(b)
The reports reporting the variances should be simple, clear and quick.
(c)
The computation and analysis of variances in respect of each element of cost

should be accurate. A wrong analysis of variances may result into misleading
conclusions.
(d)
For more effectiveness, the variances should be segregated as controllable variances

and non controllable variances. However, the analysis of uncontrollable variances
should be made with the same care as in case of controllable variances.
(e)
The reporting of variances should contain a comparison with the planned results.
(f)
The format and the contents of reports reporting the variances may depend upon
the level of management to whom reports are being made, The reports to top
management would be obviously formal containing only the broad details and final
results. The reports to lower level of management may contain the full analysis of
each variance showing the causes therefor and locating the responsibilities therefor.
ANALYSIS OF VARIANCES :
As stated earlier, the process of standard costing involves the establishment of standard
costs and the computation of actual costs under each element of cost and the comparison
between standard costs and actual costs. The difference between standard cost and actual
cost is termed as Variance. If the actual cost is less than the standard cost, the variance is
a favourable variance. If the actual cost is more than the standard cost, the variance is a
unfavorable or adverse variance. The utility of standard costing as a technique of cost control
is not complete only by the computation of variances unless these variances are further
analysed as to the causes responsible for these variances. The basic objective of variance
analysis is to classify the variances as controllable and uncontrollable ones E.g. If material
actually used is in excess of standard quantity or if time actually taken by the workers is more
than standard time, the variance will be an unfavorable one for which the responsibility can be
assigned on the executives concerned. However if the variances occur due to general strike,
general increase in wage rates, devaluation of currency, change in customers demands etc.,
the variances will be uncontrollable ones for which no responsibility can be assigned to any
executive. By concentrating most on controllable and adverse variances, it is possible for the
management to exercise control through exception which is the basic objective of standard
costing. Thus, the stress can be laid on variances only and no further action will be necessary
in cases where standard costs are matching with the actual costs, provided that the conditions
underlying the fixation of standards remain unchanged.
The variances arising in one period may be compared with a variances in the previous period
for a better control.
Thus a detailed analysis of variances, specifically the controllable ones, as to the causes
leading to these variances, and the corrective actions required to be taken to reduce these
variances enables the management to exercise proper cost control. However, it does not
mean that the favourable variances need no investigation. A constant occurrence of favourable
variance may indicate incorrect fixation of standards that need to be revised. A constant
favourable variance may be due to a genuine improvement in performance or due to the
manufacture of sub- standard products.
We will discuss the variance under each element of cost.
Standard Costing
501
(A) MATERIAL COST VARIANCE :

It is the difference between standard material cost and actual material cost. It may be
further analysed as (i)
Material Price Variance
(ii)
Material Usage Variance
(i)
Material Price Variance :
Its that portion which is due to difference between standard price specified and actual
price paid. It is calculated as Actual Quantity (Actual Price - Standard Price)
The causes for this may be traced as
(1)
Change in price of material.
(2)
Change in quantity of purchase or uneconomical size of parchase order.
(3)
Rush order to meet shortage of supply or purchase in less favourable market.
(4)
Failure to take advantage of off season prices.
(5)
Failure to get cash/trade discounts.
(6)
Weak purchase organization.
(7)
Payment of excess/less freight.
(8)
Transit losses/discrepancies if prices include them.
(9)
Change in quality or specification of material purchased.
(10) Use of substitute materials at different prices.

(11) Change in pattern or amount of taxes or duties.
From the above, it can be seen that the responsibility for this type of variance may be
normally placed on Purchase Department. However, there may be some situations where
the responsibility for this type of variance can not be placed on purchase department.
E.g. When the purchases are made in uneconomic quantities due to the lack of working
capital.
(ii)
Material Usage Variance :
It is that portion which is due to the difference between standard quantity specified and
actual quantity used. Its calculated as -
502
Standard Price (Actual Qantity - Standard Qantity)

The causes to this may be traced as :
(1)
Inefficient or careless use of materials.
(2)
Change in specification/design of the product.
(3)
Inefficient/inadequate inspection of materials.
(4)
Change in quality of material or purchases of inferior material.
(5)
Production inefficiency resulting in wastages.
(6)
Use of substitute materials.
(7)
Theft/pilferage of materials.
(8)
Inefficient labour not able to handle material properly.
(9)
Defective machines and not proper maintenance of the same.
(10) Change in the composition of material mix. If more than one materials are mixed to
get the final product, any change in the standard mix may result into material
usage variance. It may arise in case of textile, chemical, rubber industries etc.
(11) Change in the yield. If a certain amount of standard output is expected from some
inputs, any variance in actual output may result in material usage variance. It may
arise in case of processing industries.
The material usage variances may further be analysed in the following ways:
(a)
Materials Mix Variance :

As stated above, it is that part of usage variance which may arise due to change in the
standard composition of material mix where more than one materials are required to be
mixed together to get the final product. This may be a peculiar feature of the industries
like textile, chemical, rubber etc. The actual mix of materials may be different than the
standard mix due to non - availability of specified material. Increased proportion of costly
material in the mix results into adverse materials mix variance and vice-versa.
This variance is calculated as Standard price (Actual mix - Standard mix)
Standard Costing
503
(b)
Materials Yield Variance :

As stated above, it is that part of usage variance which may arise due to difference
between standard yield expected and the actual yield obtained, where a certain specified
yield is expected from a given input of materials. This may be a peculiar feature of the
processing industries. A low actual yield indicates consumplion of materials in excess
of standards set resulting into an adverse variance and vice versa.
This variance is calculated as :
Standard Yield Price (Actual Loss - Standard Loss)
Where standard yield price is calculated as :
Total Standard Cost
Total Standard Output
Illustration : I
Material
Standard
Actual
Qty.
Kgs.
Price
Rs.
Total
Rs.
Qty.
Kgs.
Price
Rs.
Total
Rs.
500
6.00
3,000
400
6.00
2,400
400
3.75
1,500
500
3.60
1.800
300
3.00
900
400
2.80
1,120
1200
1300
Less : 10%
Normal Loss
Actual
120
1,080
Loss
5,400
220
1080
5,320
Calculate material cost variances.

Solution :
(A) Material Cost Variance
Standard Material Cost - Actual Material Cost.
504
5,400 - 5,320
80 (Favourable)
(B) Material Price Variance

AQ (AP - SP) Where
AP
AQ =
Actual Quantity.
SP =
Standard Price
Actual Price
Material A
400 (6.00 - 6.00)
Nil
Material B
500 (3.60 - 3.75)
75 (Favourable)
Material C
400 (2.80 - 3.00)
80 (Favourable)
155 (Favourable)
(C)
Material Usage Variance

SP (AQ - SQ) Where
AQ
Actual Quantity
SP =
Standard Price
SQ =
Standard Quantity
Material A = 6.00 (400 - 500)
600 (Favourable)
Material B = 3.75 (500 - 400)
375 (Adverse)
Meterial C = 3.00 (400 - 300)
300 (Adveise)
75 (Adverse)
(D) Materials Mix Variance

Standard Price (Actual Mix - Standard Mix)
Material A = 6.00 (400 - 541.67)
850 (Favourable)
Material B = 3.75 (500 - 433.33)
250 (Adverse)
Material C = 3.00 (400 - 325)
225 (Adverse)
375 (Favourable)
Note : The standard mix is calculated as below.

When total input is 1,200 Kgs, the Materials A,B, and C are mixed in the proportion of 500
Kgs,, 400 Kgs and 300 Kgs. respectively. When total input is 1,300 Kgs. the materials should
have been mixed in the following proportion.
500
Material A =
1200
400
Material B =
1200
300
Material C =
Standard Costing
1200
X 1300 = 541.67 Kgs.

X 1300 = 433.33 Kgs.
X 1300 = 325.00 Kgs.
505
(E)
Materials Yield Variance

Standard Yield Price (Actual Loss - Standard Loss)
5 (220 - 130)
= 450 (adverse)
Note : Standard Yield Price is calculated as below
Total standard cost
Total standard output
Rs. 5400
= Rs.5/Per Kg.
1080 Kgs.
Check :
Material Cost Variance
= Materials Price Variance + Material Usage Variance
Materials Usage Variance = Materials Mix Variance + Materials Yield Variance

80 (F)
= 155 (F) + 375 (F) + 450 (A)
Where, F indicates favourable and A indicates adverse variance.

LABOUR COST VARIANCES :
It is the difference between standard direct wages specified and actual wages paid. It is further
analysed as (i)
Wage/Labour Rate Variance : It is that portion which is due to difference between

standard pay of wages specified and actual rate paid. It is calculated as Actual Hours (Actual Rate - Standard Rate)
The causes of this may be traced as
506
(1)
Change in wage structure or piece-work rate.
(2)
Variation due to different grades of workers and their wages differing from those
specified.
(3)
Use of different methods of payment e.g. Actual payment on time basis whereas
standards are set on piece rate basis.
(4)
Employment of casual/temporary workers to meet seasonal demands.
(5)
New workers not being allowed full normal wages.
(6)
Overtime or night shift allowance more or less than standard.
(7)
Composition of gang as regards the skill and rates of wages different than specified
standards.
Though the responsibility of wages/labour rate variances can be placed on Personnel

Department, in practice, this type of variance is usually an uncontrollable one.
(ii)
Labour Efficiency Time Variance : It is that portion which is due to difference between
standard labour hours specified and the actual labour hours expended.
It is calculated as :
Standard Rate (Actual Hours - Standard Hours)
The causes of this may be traced as :
(1)
Lack of proper supervision.
(2)
Poor working conditions.
(3)
Delays due to waiting for materials, tools, instructions etc, if not treated as idle
time.
(4)
Defective tools, equipments etc.
(5)
Machine break down if not treated as idle time.
(6)
Work on new machines requiring less time.
(7)
Basic inefficiency of workers due to lack of morale, insufficient training, faulty

instructions etc.
(8)
Use of non-standard material requiring higher lime for processing.
(9)
Operations not provided for and booking them under direct wages.
(10) Wrong selection of workers.

(11) Increase in labour turnover.
(12) Incorrect recording of performance i.e. time or output.
The labour efficiency variance may be further analysed in the following manner.
(a) Idle Time Variance : It is the standard cost of actual hours recorded as idle time due to
abnormal circumstances like strike, lock out, power failure, machinery breakdown etc. It is
calculated as Standard rate x Idle Hours
This type of variance is normally calculated separately and not kept only as a part of efficiency
variance, as the employees should not be blamed for inefficiency when the idle time arises
due to circumstances beyond their control, say power failure. It is needless to state that this
variance is always unfavorable and needs further investigation as to the causes for abnormal
idle time.
Standard Costing
507
(b)
Labour Mix Variance (Gang Composition Variance) :
It indicates that part at efficiency variance which arises due to change in Actual Gang of labour
from that of Standard Gang of labour if various grades of labour are included in a gang and if
certain grades of labour are not available. It is calculated as :
Standard Rate (Revised Standard Hours- Actual Hours)
Where the revised standard hours indicate the actual labour hours divided in the ratio of
standard hours. It should be noted that if the idle time variance is calculated separately, the
idle time hours should be excluded from actual total hours in standard ratio.
(c)
Labour Yield Variance :
In many cases, this variance is calculated separately which indicates the effect on labour cost
of actual yield or output being different from standard yield or output.
In numerical terms, it is equal to revised efficiency variance i.e. after separating Mix Variance
and Idle Time Variance from Efficiency Variance, which is calculated as Standard Rate (Standard Hours - Revised Standard Hours)
Illustration 2 :
Following details are available from the records of A Ltd. for a month regarding the standard
labour hours and rates of an hour for a product
Skilled
Semi- Skilled
Unskilled
Hours
Rate per hour Rs.
Total Rs.
10
3.00
30.00
1.50
12.00
16
1.00
16.00
58.00
The actual production for the product was 1,500 units for which the actual hours worked and
rates were as below.
508
Hours
Rate per hour Rs.
Total Rs.
Skilled
13,500
3.50
47,250
Semi- Skilled
12,600
1.80
22,680
Unskilled
30,000
1.20
36,000
Compute :
(a)
Labour Cost Variance
(b)
Labour Rate Variance
(c)
Labour Efficiency Variance
(d)
Labour Mix Variance
(a)
Labour Cost Variance :
Solution :
Standard
Hours Rate per Hr.
Actual
Total
Hours
Rate per Hr.
Total Rs.
Skilled
15,000
3.00
45,000
13,500
3.50
47,250
Semi-Skilled
12,000
1.50
18,000
12,600
1.80
22,680
Unskilled
24,000
1.00
24,000
30,000
1.20
36,000
87,000
56,100
51,000
1,05,930
Actual Cost - Standard Cost

1,05,930 - 87,000 = 18,930 (A)
(b)
Labour Rate Variance :

Actual Hours (Actual Rate - Standard Rate)
(c)
13,500 (3.50 - 3.00) =
6,750
(A)
12,600 (1.80 - 1.50) =
3,780
(A)
30,000 (1.20 - 1.00) =
6,000
(A)
16,530
(A)
Labour Efficiency Variance :

Standard Rate (Actual Hours- Standard Hours)
3.00 (13,500 - 15,000) = 4,500
(F)
1.50 (12,600 - 12,000) =
900
(A)
1.00 (30,000 - 24,000) = 6,000
(A)
2,400
(A)
Standard Costing
509
(d)
Labour Mix Variance :

Standard Rate (Actual Hours - Revised Standard Hours)
3.00 (13,500 - 16,500) = 9,000
(F)
1.50 (12,600 - 13,200) =
900
(F)
1.00 (30,000 - 26,400) = 3,600
(A)
6,300
(F)
OVERHEAD COST VARIANCES :

The analysis of overheads variances is different and the most complex task than the calculation
of material and labour variances. It is so due to the fact that establishment of a standard
overhead absorption rate is difficult as a part of total overheads is fixed, which affects the
overhead absorption rate with the change in volume.
It should be noted in this connection that the overhead absorption rate can be computed in the
following way.
(a)
If the overhead rate is expressed in terms of labour hours.

Hourly Rate
(b)
Budgeted Overhead Cost

Budgeted Labour Hours
If the overhead rate is expressed in terms of units produced

Unit Rate
Budgeted Overhead cost

Budgeted output in units
As the overheads can be either the variable overheads or fixed overheads, the overhead cost
variances may be seperately calculated for variable overheads and fixed overheads.
Variable Overheads Variance :
It is that amount of overheads which change directly with the level of activity and per unit
variable overheads remain constant. As such, the variable overheads are not affected with the
change in volume of operations.
The common method of analyzing the variable overheads variances is shown in the chart
below.
Overhead Cost Variance
Expenditure Variance
510
Efficiency Variance
(a)
Overheads Cost Variance

It is the difference between standard overheads cost absorbed and actual overheads
cost incurred. It is calculated as -
[
(b)
Standard Hours for

Actual production
Standard Hourly
Actual Overhead
Rate
Overheads Expenditure Variance :

It is the difference between the standard allowance for the output achieved and actual
overheads cost incurred.
It is calculated as Revised Budgeted Overheads for Actual Hours - Actual Overheads
(c)
Overhead Efficiency Variance :

It is due to the difference between budgeted efficiency of production and actual efficiency
attained. It is calculated as Standard Hourly
X
Rate
Standard Hours for

Actual production
Actual Overheads
Fixed Overheads Variances :

In modern times, especially in the days of rapid mechanization of production processes, the
fixed overheads form a major portion of the production cost. As such, it is necessary that the
management is properly informed about the standard fixed overheads or any deviations
therefrom. The common method of analyzing the fixed overheads variances is shown in the
chart below.
Overhead Cost Variance
Expenditure variance
Volume Variance
Efficiency
Capacity
Calender
Variance
Variance Variance
As each of the above variances can be computed either on the basis of units of production or
on the basis of hours. We will first study the nature of the above variances and then the
methods of computation.
Standard Costing
511
(a)
Overhead Cost Variance :

It is the difference between the total standard overheads cost absorbed in the output
achieved and the total actual overheads cost. Thus, it can be seen that the overheads
cost variance is simply the under or over absorption of overheads.
(b)
Expenditure Variance :
It is the difference between the standard allowance for the output achieved and the actual
overheads cost incurred.
The causes of this variance may be
(c)
(1)
Change in the quality/ price of indirect material.
(2)
Change in the labour rates for indirect workers or change in the grade of indirect
workers.
(3)
Change in the rate of power, insurance and other overheads.
Volume Variance :
It is that protion of the overhead variance which is due to the difference between the
budgeted level of output and the actual level of output.
The causes of this variance may be as below.
(1)
Labour problems like strikes, lockouts etc.
(2)
Material shortage
(3)
Machinery Breakdown
(4)
Waiting for tools/instructions/material
(5)
Power failure.
(6)
Change in the demand for product
It will not be out of place to mention here that in case of the variable overheads, per unit
or per hour overheads remain constant and are not affected by the change in the level of
output. As such, volume variance does not arise in case of variable overheads.
(d)
Efficiency Variance :
It is that portion of the overhead variances, as a part of volume variance, which is due to
the difference between budgeted efficiency of production and the actual efficiency attained.
512
(e)
(1)
Poor working conditions.
(2)
Change in the labour performance
(3)
Defective and faulty tools.
(4)
Incorrect Machine operations.
(5)
Defective or inferior material.
Capacity Variance :
It is that portion of the overhead variances, as a part volume variance, which is due to the
working at higher or lower capacity than standard.
(f)
(1)
Seasonal variations.
(2)
Shortage of labour force.
(3)
Abnormal idle time due to the reasons like power failures, strikes, lock outs etc.
(4)
Change in the customer demand.
Calender Variance :
It is that portion of overhead variances, as a part of volume variance, which is due to the
difference between the number of working days in the budget period and the actual
number of working days in the period in which the budget is applied.
Calender Variance arises only if there is abnormal increase or decrease in the number of
working days, as the normal holidays are already considered while setting the standard.
Thus, the declaration of an unexpected day as holiday may result into calender variance.
COMPUTATION OF FIXED OVERHEADS VARIANCES :

As discussed earlier, the fixed overheads variances may be computed on the basis of units of
production or on the basis of hours.
(A)
On the basis of units of production :

(1)
Overheads Cost Variance :

Standard Overhead Cost - Actual Overhead Cost
(2)
Budgeted Overhead Cost - Actual Overhead Cost
Standard Costing
513
(3)
Volume Variance :
Standard Rate per unit X [Actual Production - Budgeted Production]
(4)
Standard Rate per unit X [Actual Production - Standard Production in Actual Hours]
(5)
Capacity Variance:
Standard Rate
per unit
(6)
X Standard Production
in Actual Hours
Revised Budgeted
Production
Calender Variance :
Standard Rate per unit X [Revised Budgeted Production - Budgeted Production]
ILLUSTRATION 3 :
An Engineering Company has furnished you the following data
Budget
Actual
July 1986
No of working days
25
27
Production in Units
20,000
22,000
Fixed overheads in Rs.
30,000
34,000
Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours worked were
31,500.
Calculated the following variances.
(a)
Total overheads Variance
(b)
(c)
Volume Variance
(d)
Efficiency Variance
(e)
Capacity Variance
(f)
Calender variance
Solution :
(1)
Total Overheads Variance :

Standard Overheads Cost - Actual Overheads Cost
33,000 - 34,000
= 1,000 (A)
514
(2)
Budgeted Overheads Cost - Actual Overheads Cost
30,000 - 34,000
= 4,000 (A)
(3)
Volume Variance :
Standard Rate per unit x [Actual Production - Budgeted Production]
1.5 X (22,000 - 20,000)
= 3,000 (F)
(4)
Standard Rate per unit x [Actual Production - Standard Production in Actual Hours]
1.5 X ( 22,000 - 21,000)
= 1.500 (F)
(5)
Capacity Variance :
Standard Rate per unit x [Standard Production in Actual Hours - Revised Budgeted
Production]
1.5 X (21,000 - 21,600)
= 900 (A)
(6)
Calender Variance :
Standard Rate per Unit x [Revised Budgeted Production - Budgeted Production]
1.5 x (21,600 - 20,000)
= 2,400 (F)
Check :
Volume variance = Efficiency Variance + Capacity Variance + Calender Variance
3000 (F)
= 1500 (F) + 900 (A) + 2400 (F)
Total Variance
= Expenditure Variance + Volume Variance
1000 (A)
= 4000 (A) + 3000 (F)
Working Note :
(A)
(1)
Standard Rate per unit is calculated as below

Budgeted Overhead Cost
Budgeted Production
Standard Costing
515

(2)
30,000
20,000
Rs. 1.5 Per Unit
Standard Production in actual hours is calculated as below :

Budgeted overheads are Rs.30,000, while budgeted fixed overhead rate is Rs. l per hour.
Therefore, budgeted hours are 30,000, while budgeted production is 20,000 units. It
means that one unit requires 1.5 hours.(standard) As actual hours worked are 31.500,
the standard production in those many hours will be -
(3)
31,500
=
21,000 Units
1.5
Revised Budgeted Production is calculated as below.
Budgeted Number of working days are 25 while budgeted production is 20,000 units. It
means that standard production in one day is 20,000 Units
=
25 days
800 Units
As actual number of working days is 27, the standard production in those many days will
be 800 units x 27 days = 21,600 units
(B) On the basis of hours :
(1)

(2)
(3)
Volume Variance :
Standard Hourly Rate x [Standard Hours for Actual Production - Budgeted Hours]
(4)
Standard Hourly Rate x [Standard hours for Actual Production - Actual Hours]
(5)
Capacity Variance :
Standard Hourly Rate x [Actual Hours - Revised Budgeted Hours]
(6)
Calender Variance :
Standard Hourly Rate x [Revised Budgeted Hours - Budgeted Hours]
516
ILLUSTRATION : 4
An engineering company has furnished you with the following data.
Budget
Actual (July 1986)
25
27
Production in Units
20,000
22,000
Fixed 0verheads (in Rs.)
30,000
34,000
No. of working days
Budgeted fixed overhead rate is Rs. 1 per hour. In July 1986, the actual hours worked were
31,500.
Calculate the following variances
(a)
Total Overheads Variance
(b)
(c)
Volume Variance
(d)
Efficiency Variance
(e)
Capacity Variance
(f)
Calender Variance
Solution :
Calculation of overhead variances will be as below.
(1)
Total Overhead Variance :

Standard Overheads - Actual Overheads
33,000 - 34,000 = 1,000 (A)
(2)
Budgeted Overheads - Actual Overheads.
30,000 - 34,000 = 4,000 (A)
(3)
Volume Variance :
Standard Hourly Rate X [Standard Hours for Actual Production - Budgeted Hours]
= 1 (33,000 - 30,000) = 3,000 (F)
(4)
Standard Hourly Rate (Standard hours - Actual hours)
1 (33,000 - 31,500)
= 1,500 (F)
Standard Costing
517
(5)
Capacity Variance :
Standard Hourly Rate (Actual hours - Revised Budgeted Hours)
1 (31,500 - 32,400)
= 900 (A)
(6)
Calender Variance :
Standard Hourly Rate (Revised Budgeted Hours - Budgeted Hours)
1 (32,400 - 30,000)
= 2,400 (F)
Check :
Volume Variance = Efficiency Variance + Capacity Variance + Calender Variance.
3000 (F) = 1500 (F)+900 (A)+ 2400 (F)
Total Overhead Cost Variance = Expenditure Variance + Volume Variance
1000 (A) = 4000 (A) + 3000 (F)
Working Notes :
(1)
Standard rate per hour is known to be Rs. 1.

As Budgeted overheads are Rs.30,000, Budgeted Hours will be 30,000.
(2)
Budgeted Hours are known to be 30,000 for the Budgeted production of 20,000 units,
indicating that standard time required for one unit is 1 1/2 hours.
If the actual production is 22,000 units, the standard time required for actual production
will be 33,000 hours.
(3)
The budgeted number of working days are 25 and budgeted hours are 30,000, indicating
that the standard hours available in one day are 1,200.
If the company has actually worked for 27 days, the revised budgeted hours will be
32,400 i.e. 1,200 hours per day x 27 days.
SALES VARIANCES :
While standard costing principles are mainly applied in the area of costs i.e. Material cost,
Labour cost and overheads cost, some companies calculate the sales variances also which is
the difference between budgeted sales and actual sales and its impact on profits.
There may be two ways to calculate sales variances.
(A) The turnover/value method.
(B) The margin/profit method.
518
(A)
The Turnover/Value Method :

The common method of analysing sales variances under this method is shown in the
chart below.
Sales Value Variance
Sales Price Variance
Sales Volume Variance

Mix Variance
(1)
Quantity Variance
Sales Value Variance :

It is the difference between the budgeted sales and the actual sales.
It is calculated as Actual Sales - Budgeted Sales
(2)
Sales Price Variance :

It is that portion of sales variance which is due to the difference between standard
price specified and the actual price charged.
It is calculated as Actual Sales Volume x [Actual Price - Standard Price]
(3)
Sales Volume Variance :

It is that portion of sales variance which is due to the difference between the standard
quantity specified and the actual quantity sold.
It is calculated as Standard Price x [Actual sales volume - Standard sales volume]
(4)
Sales Mix Variance :

It is that portion of sales volume variance which may arise due to change in actual
composition of sales mix from the standard composition of sales mix, where more
than one products are dealt with.
It is calculated as Standard Sales - Revised Standard Sales
Where Standard Sales are actual quantity sold at budgeted price. Revised Budgeted sales
are standard sales rearranged in the budgeted ratio.
Standard Costing
519
Note : It should be noted that the sales mix variance, under turnover method will always
be zero. This is so because though the sales mix is varied, the actual sales at budgeted
price are rearranged in the budgeted ratio.
(5)
Sales Quantity Variance :

It is that portion of sales volume variance, which may arise due to the difference between
standard value of actual sales at standard mix and budgeted sales. It is calculated as Revised Standard Sales - Budgeted Sales.
Illustration 5 :
Standard
Actual
Product
Qty.
Sale Price
Rs.
Total
Rs.
Qty.
Sale Price
Rs.
Total
Rs.
A.
500
2,500
500
5.40
2,700
B.
400
2,400
600
5.50
3,300
C.
300
2,100
400
7.50
3,000
7,000
1500
1200
9,000
Calculate the Sales Variances.

Solution :
(A)
(1)
Sales Value Variance :

Actual Sales - Budgeted Sales
(2)
7,000 - 9,000 = 2,000 (F)

Actual Sales Volume (Actual Price - Standard Price)
520
A - 500 (5.40 - 5.00) =
200
(F)
B - 600 (5.50 - 6.00) =
300
(A)
C - 400 (7.50 - 7.00) =
200
(F)
100
(F)
(3)

Standard Price (Actual Sales Volume - Standard Sales Volume)
(4)
A - 5 (500 - 500)
Nil
B - 6 (600 - 400)
1200
(F)
C - 7 (400 - 300)
700
(F)
1900
(F)

Standard Sales - Revised Standard Sales
Where standard sales are actual quantity at standard price and Revised standard sales are
standard sales rearranged in budgeted ratio.
Standard Sales
Revised Standard Sale
Qty.
Price Rs.
Total Rs.
Ratio
Total
500
2500
35.71%
3178
600
3600
34.29%
3052
400
2800
30.00%
2670
8900
8900
Ratio is calculated as below

A
2500
7000
2400
7000
2100
7000
100
35.71%
100
34.29
100
30%
Sales Mix Variance A
2500 - 3178 = 678
(A)
3600 - 3052 = 548
(F)
2800 - 2670 = 130
(F)
Nil
Standard Costing
521
(5)
Sales Quantity Variance

Revised Standard Sales - Budgeted Sales :
A
3178 - 2500
678
(F)
3052 - 2400
652
(F)
2670 - 2100
570
(F)
1900
(F)
=
Check :
Sales Value Variance = Sales Price Variance + Sales Mix Variance + Sales Quantity Variance
= 2000 (F) = 100(F)+Nil +1900 (F)
(B) The Margin / Profit Method :
This method of sales variances measures the effect of actual sales and budgeted sales on
profit. As this method does not consider the cost variances, all costs are assumed to be
standard costs. The common method of analysing sales variances under this method is
shown in the chart below.
Total Sales Margin Variance
Sales Margin Price Variance
Sales Margin Volume Variance

Sales Margin
Mix Variance
(1)
Sales Margin
Quantity Variance
Total Sales Margin Variance :

It is the difference between actual margin (by considering standard costs) and budgeted
margin.
It is calculated as Actual Profit - Budgeted Profit
(2)
Sales Margin Price Variance :

It is that portion of total sales margin variance which is due to the difference between
standard price of actual sales made and actual price.
It is calculated as
Actual Profit - Standard Profit
522
(3)
Sales Margin Volume Variance :

It is that portion of total sales-margin variance which is due to the difference between
standard profit and budgeted profit.
It is calculated as Standard Profit - Budgeted Profit.
(4)
Sales Margin Mix Variance :

It is that portion of sales margin volume variance which is due to the difference between
standard profit and revised standard profits.
It is calculated as Standard Profit - Revised Standard Profit.
(5)
Sales Margin Quantity Variance :

It is that portion of sales margin volume variance which is due to the difference between
budgeted profit and revised standard profits.
It is calculated asRevised Standard Profits - Budgeted Profit.
Illustration 6 :
A Ltd. has budgeted the following sales for the month
A - 900 units at Rs. 50 per unit.
B - 650 units at Rs, 100 per unit.
C - 1200 units at Rs. 75 per unit.
Actual sales were A - 950 units at Rs. 58 per unit.
B - 700 units at Rs. 90 per unit.
C - 1200 units at Rs. 80 per unit.
Costs per unit of A, B and C were Rs. 40, Rs. 88 and Rs.60 respectively.
Compute the Sales Margin variances.
Standard Costing
523
Solution :
SALES
Product
COST OF SALES
PROFIT
Qty
Price
Rs.
Total
Rs.
Per unit
Rs.
Total Per unit

Rs.
Total
Rs.
900
50
45,000
40
36,000
10
9,000
650
100
65,000
88
57,200
12
7,800
1200
75
90,000
60
72,000
15,
18,000
BUDGET
2,00,000
1,65,200
34,800
ACTUAL
A
950
58
55,100
40
38,000
18
17,100
700
90
63,000
88
61,600
1,400
1200
80
96,000
60
72,000
20
24,000
2,14,100
1,71,600
42,500
Standard sales and revised standard sales are calculated as below

STANDARD SALES :
SALES
COST OF SALES
PROFIT
Product
Qty
Price
Rs.
Total
Rs.
Per unit
Rs.
950
50
47,500
40
38,000
10
9,500
700
100
70,000
88
61,600
12
8,400
1200
75
90,000
60
72,000
15
18,000
2,07,500
Total Per unit

Rs.
1,71,600
Total
Rs.
35,900
REVISED STANDARD SALE

Product
524
Revised
Standard sales
Revised
Standard profit
Rs.
Rs.
46,688
9,338
67,437
8,092
93,375
18,675
2,07,500
36,105
Calculation of Variances
(1)
Total Sales Margin Variance :

Actual Profit - Budgeted Profit
42,500 - 34,800 = 7,700 (F)
(2)
Sales Margin Price Variance

42,500 - 35,900 = 6,600 (F)
(3)
Sales Margin Volume Variance

Standard Profit - Budgeted Profit.
35,900 - 34,800 = 1,100 (F)
(4)

Standard Profit - Revised Standard Profit.
35.900 - 36,105 = 205 (A)
(5)

Revised Standard Profit - Budgeted Profit
36,105 - 34,800 = 1,305 (F)
(1)
Following standard and actual data relates to a manufacturing concern.

Material
Standard
40 kgs. at Rs. 6
240
60 kgs. at Rs. 4
240
480
Standard output is 80% of input i.e. 80 units. Process loss is 20%.

Material
Actual
600 kgs. at Rs. 4
400 kgs. at Rs. 6
Actual output is 70% of input i.e. 700 units. Process loss is 30%.
Standard Costing
525
Calculate
(1)
Cost variance
(2)
Price variance
(3)
Total Quantity usage variance
(4)
Mix variance
(5)
Revised usage variance
Solution :
(1)
Cost Variance :
Actual Material Cost - Standard material Cost
4800 - 4200 = 600 (A)
(2)
Price Variance :
Actual Quantity (Actual Price - Standard Price)
(3)
X 600 (4-6)
1200
(F)
Y 400 (6-4)
800
(A)
400
(F)
Total Usage Variance :

Standard Price (Actual Quantity - Standard Quantity)
(4)
X - 6 ( 600 - 350)
1500
(A)
Y - 4 ( 400 - 525)
500
(F)
1000
(A)
Mix Variance :
Standard Price (Actual Mix- Revised Standard Quantity
(5)
X - 6 (600 - 400)
1200
(A)
Y - 4 (400-600)
800
(F)
400
(A)
Revised Usage Variance :

Standard Price (Revised Standard Quantity - Standard Quantity)
X - 6 (400 - 350)
Y - 4 ( 600 - 525)
526
=
=
300
(A)
300
(A)
600
(A)
(6)
Yield Variance :
Standard Cost per unit (Actual Loss - Standard Loss)
6 (300 - 200) = 600 (A)
Check :
Cost Variance = Price Variance + Mix Variance + Yield Variance
600 (A) = 400 (F) + 400 (A) + 600 (A)
Notes :
(1)
Standard Cost is calculated as below .

Standard input for the output of 80 units is 100 kgs.
If the actual output is 700 units, the standard input for the same will be 700
X 100
80
875 kgs.
The standard proportion of the materials is 40% for X and 60% for Y. As such, for the
standard input of 875 kgs, the standard proportion will be X - 40% of 875 kgs i.e. 350 kgs.
Y - 60% of 875 kgs i.e. 5:25 kgs.
The standard cost will be as follows.
Material
X
Y
Standard
Quantity
kgs.
350
525
Standard
Price
Rs.
6
4
Cost
Rs.
2,100
2,100
4.200
(2)
Revised standard quantity is calculated as below.

Total input is 1000 kgs. The standard proportion of the materials is 40% for X and 60%
for. Y. As such, the revised standard quantity should have been X - 40% of 1000 kgs. i.e. 400 kgs.
Y - 60% of 1000 kgs. i.e. 600 kgs.
Standard Costing
527
(3)
The standard material cost of a normal mix of one tonne of chemical X is based on
Chemical
A
B
C
Usage Kgs.
240
400
640
Price per Kg.

6
12
10
During a month, 6.25 tonnes of X were produced from

Chemical
A
B
C
Consumption
(Tonnes)
1.6
2.4
4.5
Cost
(Rs.)
11,200
30,000
47,250
Analyse the variances.

Solution :
Calculation of standard cost
Chemical
A
B
C
Quantity
kgs.
1500
2500
4000
Rate per kg.

Rs.
6
12
10
Total Cost
Rs.
9,000
30,000
40,000
79.000
Calculation of Actual cost

Chemical
A
B
C
Quantity
kgs.
1600
2400
4500
Rate per kg.

Rs.
7
12.5
10.5
Total cost
Rs.
11,200
30,000
47,250
88,450
(1)
Material Cost Variance :

Standard Cost - Actual Cost
79,000 - 88,450
= 9,450 (A)
528
(2)
Material Price Variance :

Actual Quantity (Actual Price - Standard Price)
A - 1600 (7-6)
1,600
(A)
B - 2400 (12.5-12)
1,200
(A)
2,250
(A)
5,050
(A)
C - 4500 (10.5 - 10)
(3)
Material Usage Variance :

Standard Price (Actual Quantity - Standard Quantity)
(4)
A - 6 (1,600 - 1500)
600
(A)
B - 12 (2,400 - 2500)
1200
(F)
C - 10 (4,500 - 4000)
5000
(A)
4,400
(A)
Material Mix Variance :

Standard Price (Actual Mix - Standard Mix)
A - 6 (1,600 - 1593.75) =
37.5
(A)
B - 12 (2,400 - 2656.25) =
3075.0
(F)
C - 10 (4500 - 4250)
2500.0
(A)
537.5
(F)
Note : The standard mix is calculated as below. When total input is 8000 kgs. Chemicals A,
B and C are mixed in the proportion of 1500 kgs, 2500 kgs and 4000 kgs respectively. When
total input is 8500 kgs, the chemicals should have been mixed in the following proportion.
Chemical A -
1500
8500
= 1593.75 kgs.
8500
= 2656.25 kgs.
8500
8000
Chemical B -
2500
8000
4000
Chemical C -
4250 kgs.
8000
Standard Costing
529
(5)
Material Sub-usage Variance :

Standard Price (Standard Quantity - Standard Mix)
A - 6 (1500 - 1593.75)
562.5 (A)
B - 12 (2500 - 2656.25)
1875.0 (A)
C - 10 (4000 - 4250)
2500.0 (A)
4937.5 (A)
(6)
XYZ forecasts its overhead expenditure for a period as under.

Rs. 30,000 for 10,000 hours.
Rs. 27,500 for 9,000 hours.
Rs. 25,000 for 8,000 hours.
The normal volume of activity is 10,000 hours. During a period 8,750 hours were utilised for a
total overhead expenditure of Rs. 28,750 of which fixed overheads totalled to Rs. 5,250. The
standard utilisation of labour should have been less by 5%.
How will you analyse the overhead variance.
Solution :
From the variation of total overheads, it is noted that for the variation of 1,000 hours. The
overheads very to the extent of Rs. 2,500. Thus, indicates that the rate of variable overheads
is Rs. 2.50 per hour. At the normal level of activity, the distribution of overheads will be as
below.
Variable Overheads - 10,000 hours x Rs.2.50
Rs. 25,000
Fixed Overheads - Balance
Rs.
5,000
Rs. 30,000
Variable Overheads Variances :
(1)

Hours for
[ Standard
actual production
530
X Standard Hourly Rate - Actual Overheads
8930 X 2.50 - 23.500
22,325 - 23,500 = 1,175 (A)
(2)
[Revised Budgeted Overheads for Actual hours] - Actual Overheads.
8,750 x 2.50 - 23,500
= 21,875 - 23,500 = 1,625 (A)

(3)
[Standard Hours for Actual Production - Actual Hours] x Standard Hourly Rate
[8,930 - 8.750] x 2.50
= 450 (F)
Notes :
(a)
Total overheads cost actually incurred is Rs. 28,750 out of which fixed overheads are
Rs. 5,250. Hence, balance is variable overheads i.e.
Rs. 28,750 - Rs. 5,250 = Rs. 23,500
(b)
Standard Hourly Rate is calculated as below.

Total Budgeted Variable Overheads/Total Budgeted Hours.
=
Rs. 25,000
Rs. 2.50 per hour.
10,000
(c)
Standard-hours for actual production are calculated as below.

Actual overheads are Rs. 23,500. As the standard hourly rate is Rs.2.50 per hour, the
ideal hours should have been
Rs. 32,500
= 9,400
Rs. 2.50
However, standard utilisation should have been less by 5%.
Hence, standard hours will be 95% of 9,400 hours i.e. 8,930 hours.
(d)
Revised budgeted overheads for Actual Hours are worked out as below.
Actual hours are 8,750 and standard hourly rate is Rs. 2.50 per hour.
Hence, the revised budgeted overheads should have been Rs. 21,875 i.e. 8,750 x 2.50.
Standard Costing
531
Check :
Overheads Cost Variance = Expenditure Variance + Efficiency Variance
1175 (A) = 1625 (A) + 450 (F)
Fixed Overheads Variance :
(1)

4,987.5 - 5,250 = 262.5 (A)
(2)
Overheads Expenditure Variance :

5000 - 5250 = 250 (A)
(3)
Overheads Volume Variance :

Standard Hourly Rate x [Standard Hours for Actual Production - Budgeted Hours]
0.50 X (9,975 - 10,000) = 0.50 x 25
= 12.5 (A)
(4)
Overheads Efficiency Variance :

Standard Hourly Rate x [Standard Hours for Actual Production - Actual Hours]
0.50 X (9,975 - 8750) = 0.50 x 1225
= 612.5 (F)
(5)
Overheads Capacity Variance :

Standard Hourly Rate X [Actual Hours - Budgeted Hours]
0.50 X (8,750 - 10,000) = 0.50 x 1250
= 625 (A)
Notes :
(a)
Standard Hourly Rate is calculated as below,

Total Budgeted Fixed Overhead
Total Budgeted Hours
Rs. 5,000
= Rs. 0.50 per hour
10,000
532
(b)
Standard Hours for actual production are calculated as below.

Actual Overheads are Rs. 5,250. As the standard hourly rate is Rs, 0.50 per hour, the
ideal hours should have been 10,500.
However, standard utilisation should have been less by 5%. Hence, standard hours will
be 95% of 10,500 hours i.e. 9,975 hours.,
(c)
Standard overheads cost is calculated as

Standard Hours x Standard Hourly Rate
9,975 x 0.50 = 4,987.50
(d)
As the details of capacity variation due to the change in the number of working days is
not known, calender variance cannot be calculated. As such, the calculation of capacity
variance is made on the basis of comparison between actual hours and budgeted hours.
Check :
Overheads Cost Variance = Expenditure Variance + Efficiency Variance + Capacity Variance.
= 262.5 (A) = 250 (A)+612.5 (F)+625 (A)
(4)
The sales manager a company engaged in the manufacture and sale of three products P,
Q and R gives you are following information for the month of October 1982.
Budgeted Sales :
Product
Units sold
Selling Price
Per unit
Rs.
Standard
Margin per
unit Rs.
2,000
12
2,000
2,000
Actual Sales
P - 1,500 units for Rs. 15,000
Q - 2,500 units for Rs. l7,500
R - 3,500 units for Rs. 21,000
You are required to Calculate the following variances
(i)
The Sales Price Variance
(ii)
The Sales Volume Variance
(iii) The Sales Quantity Variance

(iv)
The Sales Mix Variance
Standard Costing
533
Solution :
(A) As per Turnover/ Value Method :
(1)
Actual Sales Volume (Actual Price - Standard Price)

P - 1,500 (10 - 12)
3,000
(A)
Q - 2,500 (7 - 8)
2,500
(A)
R - 3,500 (6 - 5)
3,500
(F)
2,000
(A)
(2)
Standard Price (Actual Sales Volume - Standard Sales Volume)

P - 12 (1,500 - 2,000)
6,000
(A)
Q - 8 ( 2,500 - 2,000)
4,000
(F)
R - 5 (3,500 - 2,000)
7,500
(F)
5,500
(P)
(3)
Standard Sales - Revised Standard Sales

Where standard sales are actual quantity at standard price and revised standard sales
are standard sales rearranged in budgeted ratio.
Qty.
Standard Sales
Price Rs.
Total Rs.
Revised Standard Sales

Ratio
Total Rs.
1,500
12
18,000
1/3
18,500
2,500
20,000
1/3
18,500
3,500
17,500
1/3
18,500
55,500
55,500

P
18,000
18,500
500 (A)
20,000
18,500
1,500 (F)
17,500
18,500
1,000 (A)
NIL
534
(4)
Sales Quantity Variance :
Revised Standard Sales - Budgeted Sales :

P - 18,500 - 2,000 x 12
5,500
(A)
Q - 18,500 - 2,000 x 8
2,500
(F)
Q - 18,500 - 2,000 X 5
8,500
(F)
5,500
(B) As per Margin/ Profit Method
Cost per unit = Selling price per unit - Contribution per unit
P
12 - 6
=6
8 -4
=4
5 -l
=4
PRODUCT
SALES
COST OF SALES
PROFIT
Qty.
Price Rs.
Total Rs.
Per unit Rs.
Total Rs.
Per unit Rs.
Total Rs.
2,000
12
24,000
12,000
12,000
2,000
16,000
8,000
8,000
2,000
10,000
8,000
2,000
Budgeted
50,000
28,000
22,000
Actual
P
1,500
10
15,000
9,000
6,000
2,500
17,500
10,000
7,500
3,500
21,000
14,000
7,000
53,500
33,000
20,500
Standard sales and revised standard sales are calculated as below :

Standard Sales
P
1,500
12
18,000
9,000
9,000
2,500
20,000
10,000
10,000
3,500
17,500
14,000
3,500
55,500
Standard Costing
33,000
22,500
535
Revised Standard Sales
(1)
Revised Standard
Sales Rs.
Revised Standard
Profit Rs.
25,680
12,840
17,120
8,560
10,700
2,140
53,500
23,540
Sales Margin Price Variance :

(2)
20,500 - 22,500 = 2,000 (A)
Sales Margin Volume Variance :

Standard Profit - Budgeted Profit
22,500 - 22,000 = 500 (F)
(3)

Standard Profit - Revised Standard Profit
22,500 - 23,540 = 1,040 (A)
(4)

Revised standard Profit - Budgeted Profit
23,540 - 22,000 = 1,540 (F)
QUESTIONS
1.
What do you mean by standard costing?

Differentiate between Standard Costing and Budgetary Control as cost control techniques.
state the advantages and limitations of standard costing.
2.
What do you understand by standard costing?

What preliminaries will have to be complied with before introducing the technique of
standard costing.
536
3.
Describe the procedure of establishing standard costs in the area of materials cost,
labour cost and overheads cost.
4.
What do you mean by variances and variance analysis. Explain the various factors
affecting the variances in the area of materials cost, labour cost and overheads cost.
PROBLEMS
1.
The standard materials cost to produce a tonne of chemcial X is

300 kgs of material A @ Rs. 10 per kg.
400 kgs of material B @ Rs. 5 per kg.
500 kgs of material C @ Rs. 6 per kg.
During the period 100 tones of chemical X were produced from the usage of
35 tonnes of material A for a cost of Rs.9,000 per tonne
42 tonnes of material B for a cost of Rs. 6,000 per tonne
53 tonnes of material C for a cost of Rs. 7,000 per tonne
Calculate price, mix and usage variances.
2.
Mixers Ltd. is engaged in producing a standard mix using 60 kgs. of chemical X and 40
kgs of chemical Y. The standard loss of production is 30%. The standard price of X is
Rs.5 per kg. and of Y is Rs. 10 per kg.
The actual mixture and yield were as follows.
X 80 kgs. @ Rs. 4.50 per leg and
Y 70 kgs @ Rs.8.00 per kg.
Actual yield 115 kgs.
Calculate material variances (Price, Usage, Yield, Mix)
3.
4.
Given that the cost standards for material consumption are 40 kgs at Rs. 10 per kg.,
compute the variance when the actuals are
a.
48 kgs @ Rs. 10 per kg.
b.
c.
d.
The standard cost of material for manufacturing a unit of a particular product FEE is
estimated as follows.
16 kgs of raw material @ Re. 1 per kg.
On completion of the unit, it was found that 20 kgs of raw material costing Rs.1.50 per
kg. has been consumed. Compute material variances (price, usage, cost)
5.
A company manufacturing distempers operates a standard costing system. The standard

cost for one of the products of the company shows the following materials standards.
Standard Costing
537
Materials
Quantity
A
B
C
40
10
50
Standard Price
per kg Rs.
75
50
20
Total Rs.
3,000
500
1,000
Material cost per unit (Total) 4,500

The standard input mix is 100 kgs and the standard output of the finished product is 90
kgs.
The actual results for a period are
Material Used.
A - 2,40,000 kgs @ Rs. 80/kg
B - 40,000 kgs. @ Rs. 52/kg
C - 2,20,000 kgs @ Rs. 21/kg
Actual output of the finished product - 4,20,000 kgs.
Yon are required to calculated the material price, mix and yield variance.
6.
In a factory 100 workers are engaged and the average rate of wages is 50 paise. Standard
working hours per week are 40 and the standard performance is 10 units per gang hour.
During a week in March, wages paid for 40 workers were at the rate of 50 paise per hour,
10 workers at 70 paise per hour and 40 workers at 40 paise per hour. Actual output was
380 units.
Factory did not work for 5 hours due to breakdown of machinery. Calculate appropriate
labour variances
7.
The standard cost of a unit shows the following costs of material and labour
Material 4 pices @ Rs. 5.00
Labour 10 hours @ Rs. 1.50
5,700 units of the product were manufactured during the month of March 1987 with the
following material and labour costs.
Material 23,000 pieces at Rs. 4.95
Labour 56,800 hours at Rs. 1.52
538
You are required to calculate
8.
(1)
Material Price variance
(2)
Material Cost variance
(3)
Material Usage variance
(4)
Labour Rate variance
(5)
Labour Efficiency variance
(6)
Labour Cost variance
The standard labour component and the actual labour component engaged in a week for
a job are as under.
(a)
Skilled
Workeis
Semi Skilled
Workers
Unskilled
Workers
32
12
28
18
Standard number of workers

in the gang
(b)
Standard wage rate per hour (Rs.)
(c)
Actual number of workers employed

in the gang during the week.
(d)
Actual wage rate per hour (Rs.)
During the 40 hours working week, the gang produced 1800 standard hours of work.
Calculate the following variances.
(i)
Labour cost variance
(ii)
Labour efficiency variance
(iii) Labour rate variance

(iv)
9.
Labour mix variance
Items
No. of working days
Month hours per day
Output per manhour in units
Overhead cost (Rs.)
Budget
Actual
20
22
8,000
8,400
1.0
0.9
1,60,000
1,68,000
Calculate overhead variances.

10. From the following data of A Co. Ltd. relating to budgeted and actual performance for the
month of March 87, compute the Direct Material and Direct Labour cost variances.
Standard Costing
539
Budgeted data for March :

Units to be manufactured
1,50,000
Units of direct material required

(Based on standard rates)
4,95,000
Planned purchases of Raw Materials (Units)
5,40,000
Average unit cost of Direct Material

Direct Labour hours per unit of finished goods
Direct Labour cost (Total) Rs.
Rs.8
3/4 hr.
29,92,500
Actual data at the end of March :

Units actually manufactured
1,60,000

(Purchase cost based on units actually issued) Rs.
43,41,900

(Purchase cost based on units actually purchased) Rs.
Average unit cost of Direct Material
Rs.8.20
Total Direct Labour hours for March
1,25,000
Total Direct Labour cost for March.

11.
45,10,000
Rs. 33,75,000
The following details relating to the Product X during the month of March 1989 are available.
You are required to compute the material and labour cost variance and also to reconcile
the standard and the actual cost with the help of such variances.
Standard cost per unit
Materials 50 kgs. @ Rs. 40 per kg.
Labour 400 hours @ Rs. 1.00 per hour.
Actual cost for the month Material 4900 kgs @ Rs. 42 per kg.
Labour 39,600 hours @ Rs. 1.10 per hour
Actual production - 100 units.
540
12. Following data are available in respect of a particular department for weekly operations:
Standard output for 40 hours week
- 2,000 units
Standard fixed overheads
- Rs. 2,000
Actual output
- 1,800 units
Actual hours worked
- 32
Actual fixed overheads
-Rs. 2,250
Calculate overhead variances

13. Dustfree Products manufactures and sells a patented vaccum cleaner for domestic use
and the following data is available for October 1983.
Actual
Standard
Direct Labour hours
10,500
Direct Labour cost (Rs.)

Direct Material (Tonnes)
Direct Material cost (Rs.)
21,500
550
52,250
10,000
(10 hrs. per unit)
2.10 per hour
540
100 per Tonne
Actuals
(For October)
Budgeted
(For the year)
6,200
15,200
72,000
216,000
Overheads: Fixed
Variable (varies with volume
of production)
Overhead is budgeted for normal activity of 1,44,000 hours of direct labour per annum,
equally phased.
Compute labour, material and overheads variances.
14. The budgeted and actual sales of a concern manufacturing and marketing a single product
are furnished below.
Budgeted sales
Qty.
Price per
Amount
Qty.
Units Rs.
Rs.
units
Rs.
Rs.
3.00
30,000
5,000
3.00
15,000
8,000
2.50
20,000
10,000
Actual sales
Price per unit
Amount
Ascertain,
(a)
(b)
Sales Volume Variance.
Standard Costing
541
17. From the following information about sales, calculate

(a)
Total Sales Variance
(b)
(c)
(d)
Sales Mix Variance
(e)
Sales Quantity Variance
Product
Nos.
5,000
B
C
Standard
Rate (Rs.)
Actual
Rate (Rs.)
Rs.
Nos.
25,000
6,000
36,000
4,000
24,000
5,000
25,000
3,000
21,000
4,000
32,000
70,000
15,000
12,000
Rs.
93,000
18. Budgeted and actual sales for a month of two products A and B were as below
Units
A
Budget
Unit Price
Rs.
3,000
5,000
10.00
2.00
Actual
Units
Unit Price
Rs.
2,500
10.00
1,000
9.50
4,000
2.00
1,200
1.90
Budgeted costs for the products A and B were Rs.8 and Rs. 1.50 respectively. Work out
the following variances.
(a)
Sales Value Variance
(b)
(c)
(d)
Sales Mix Variance
(e)
Sales Qunatity Variance
19. X Ltd. operates a budgetory control and standard costing system.

From the following data calculate
542
(a)
Sales Variance
(b)
(c)
Product
Budgeted
Units to be
Sales Value
Rs.
Actual
Units sold
Sales value
Rs.
100
1,200
100
1,100
50
600
50
600
100
900
200
1,700
75
450
50
300
325
3,150
400
3,700
20. The records of an engineering company indicate the following for the month of April 1986
Standards
Factors
Unit cost (Rs.)
Direct Materials
4 gallons @ Rs. 1.20
4.80
Direct Labour
3 hours @ Rs. 1.80
5.40
Factory overheads Rs.0.60 per labour hour
1.80
Total manufacturing cost
12.00
Activity for the month of April 1986 (1)
Production during the month of April 1986 has been 6,500 units with no beginning
or ending work in progress inventories.
(2)
Materials purchased 32,000 gallons @ Rs. 1.18 per gallon. Used in production
25,600 gallons.
(3)
Labour hours worked 20,000. Average hourly wage rate Rs. 1.75
(4)
Factory overheads - Total overheads costs incurred Rs. 12,500
Calculate material variances, labour variances and total variance for factory overheads.
21. A factory supplies the following figures of production and overheads for September 1983
Budgeted
Actual
50,000
52,000
Variable overheads (Rs.)
4,00,000
4,10,000
Fixed overheads (Rs.)
6,00,000
6,20,000
Number of hours
2,00,000
2,20,000
Production (Units)
Work out the variances that are involved.
Standard Costing
543
22. It is estimated that in the manufacture of a product, for each ton of material consumed,
100 articles should be produced. The Standard Price per ton of material is Rs. 10. During
the first week of January, 200 tons of materials were issued to the production department,
the purchase price of which was Rs. 10.50 per ton. The actual output for the period was
20,500 units.
Calculate the Material Variances.
544
NOTES
Standard Costing
545
NOTES
546
Chapter 14
UNIFORM COSTING
It refers to the use of same costing principles and methods by several undertakings. Its not a
separate method of cost accounting but only a particular technique which applies the usual
accounting methods like process costing, job costing, standard costing, budgetory costing
and marginal costing. Main feature of uniform costing is that whenever a particular method of
costing is applied it is applied uniformly in a number of concerns in the same industry or even
different but similar industries. This enables cost and accounting data of the member undertakings
to be compiled on a comparable basis so that useful and crucial decisions can be taken. It
attempts to establish uniform methods so that comparison of performances in the various
undertakings can be made to the common advantages of all the constituent units.
Scope of Uniform Costing :
Uniform costing methods may be advantageously applied (i)
In single organisation having a number of branches, each of which may be a separate

manufacturing unit. In this case, the head office controls the operations of the uniform
costing methods.
(ii)
In a number of concerns in the same industry bound together through a trade association
or otherwise. In this case, the procedure for uniform costing may be devised and controlled
by the association or any other central body prescribed for this purpose.
(iii) In industries which are similar such as gas and electricity, cotton, jute and woolen
textiles.
Requisites for uniform costing :
The success of uniform costing will depend upon the following :
(1)
There should be a spirit of mutual trust and policy of give and take.
(2)
There should be free exchange of ideas and methods.
Uniform Costing
547
(3)
Bigger units should be ready to share with smaller ones, improvements, achievements
of efficiency and know how.
(4)
There should not be any hiding or withholding of information.
(5)
There should be no rivalry, competition or sense of jealousy among the members.
Advantages of uniform costing :

(1)
Uniform costing is a useful tool for management control. Performances of individual units
can be measured against norms set for the industry as a whole.
(2)
It avoids cut throat competition by ensuring that competition among the members will
proceed on healthy lines.
(3)
Weaker units in the industry can take the advantage of the efficient methods of production
and production control of better managed units so as to increase their own efficiency.
(4)
The fruits of the research and development programmes which can be carried out only by
the bigger units, may be shared by the smaller units.
(5)
By showing one best way of doing things, it creates cost consciousness and provides
the best system of cost control or cost presentation in the entire industry.
(6)
Prices based on uniform costing may be taken to be reliable and representative of the
whole industry. This creates customer confidence and improves relations between
customer and business.
(7)
It assists in educating the less informed units as regards the cost accounting methods.
(8)
In India, where public undertakings operate alongwith the private sector undertakings,
uniform costing enables a comparitive assessment to be made of the two sectors.
(9)
Uniform costing enables the furnishing of suitable statistics to the Government wherever
called upon to do so. This may be required by Government for effective price control or to
give protection or subsidy to a particular industry etc.
(10) It simplifies the work of wage boards set up to fix minimum wages and fair wages for an
industry.
548
Disadvantages of Uniform Costing :

(1)
The practices and methods followed by various units in the industry may vary from one
unit to another. The factors for such differences like location, age, capital investment and
condition of plant, degree of mechanisation etc. may be so wide from each other that to
have a uniform costing system suitable for big as will as small units becomes impossible.
(2)
For small units, cost of installation and operation of uniform costing system may not be
commensurate to the advantages therefrom.
(3)
If some reservations are made while giving certain information by some units or if some
information is withheld on the grounds of secrecy or privacy, the statistics presented
cannot be relied upon.
(4)
It may create conditions which are likely to develop monopolistic tendencies within the
industry. Prices may be raised arbitrarily and supplies curtailed.
Fields covered by uniform costing :

Considering the basic nature of uniform costing as discussed above, it goes without saying
that the success of uniform costing system depends upon the extent to which uniformity can
be brought about in various areas. The various areas in which uniformly can be attempted to
be brought are as discussed below.
(1)
Method of cost accounting to be implemented viz. job costing, process costing, unit
costing and so on.
(2)
Costing Techniques employed i.e. marginal costing, standard costing etc.
(3)
Methods of pricing the issues from stores. viz. FIFO, LIFO, Weighted Average and so
on.
(4)
Method followed for valuation of inventories.
(5)
Methods followed for inventory control.
(6)
Method followed for charging depreciation viz. written down value, straight line etc.
(7)
Methods of remunerating the workers.
(8)
Treatment given to certain specific types of costs like bonus, idle time wages and so on.
(9)
Methods for apportionment and absorption of overheads and treatment given to under or
over absorption of overheads.
(10) Treatment given to material scrap, wastes, spoilages and defectives.
Uniform Costing
549
(11) Treatment given to research and development costs.

(12) Definition of the term capacity for setting overhead absorption rates.
(13) Procedure for classification and codification of accounts.
(14) Items to be excluded from cost accounts.
Uniform Cost Manual :
It is a document which lays down the cost accounting plans and procedures to be followed by
the constituent units. This document once circulated among the constituent units helps to
guide them to formulate their system of accounting in such a way that the principles of uniform
costing can be uniformly and correctly applied.
The various contents of an uniform cost manual can be stated us below :
550
(1)
Introduction : This part may state the objects and purposes of uniform cost system,
advantages derived therefrom and the cooperation expected from constituent units.
(2)
Organisation : This part may include the organisation for establishing and running the
uniform cost system. E.g. whether the system is to be established and run by outside
cost consultants or by those internal to the various constituent units.
(3)
Cost Accounting System : This part includes accounting systems and procedures to
be followed lo bring about uniformity E.g. classification and codification of accounts,
definition of a cost centre and cost unit, relationship between cost and financial accounting,
items to he included in or excluded from cost accounting, collection of various costs viz.
material, labour and overheads and so on.
(4)
Presentation of information : This part may include the forms and contents of various
cost and financial ratios, presentation of various production and operation costs and so
on.
(5)
Miscellaneous : This part may include any of their information to be communicated to

the constituent units but not included in any of the above mentioned sections.
QUESTIONS
1.
What are the advantages and limitations of uniform costing?
2.
Write short notes Uniform Costing Manual
3.
What do you mean by Uniform Costing? What are the various advantages and
disadvantages of Uniform Costing? State the pre-requisites for the success of Uniform
Costing. Explain the various areas where uniform costing can be used.
Uniform Costing
551
NOTES
552

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A-PDF MERGER DEMO

Prof. Satish Inamdar

(FOR PRIVATE CIRCULATION ONLY)

Symbiosis Center for Distance Learning,

Symbiosis Center for Distance Learning (SCDL)

Prof. Satish Inamdar

ABOUT THE AUTHOR

Principals, Convention and Concepts of Accounting

Glossary of Terms Used in Financial Accounting

Problems for Students to Solve

Bank Reconciliation Statement

Disadvantages/Limitations of Management Accounting

Basics of Financial Accounting

Illustration with Solution

Illustration with Solutions and Problems for

Cost Accountancy (Basic Concepts and Principles)

Concept of Cost Centre

Illustration of Costing System

Illustrative Problems with Solutions

Procurement / Issue of Material, P.O., GRN, MRN,

Techniques of Inventory Control

Illustrative Problems with Solution

Time Keeping Methods

Important Terms in Case of Labour Cost

Problems for Students to Solve

Procedure for Charging the Overheads

Problems for Students to Solve

Form of Operating Statement

Profit Volume Ratio, Bank Even Point, Margin of Safety

Cost, Volume, Profit Relationship

Illustrations with Solutions

Budgets and Budgetary Control, Advantages, pre-requisites

Fixed and Flexible Budget

Problems for Students to Solve

Concept of Standard Cost and Standard Costing

Standard Costing Compared with Budgetary Control

Illustrations and Solutions

Assignment Question Bank

Let us discuss the nature of these three streams of accounting in details.

Financial Accounting considers those transactions which can be expressed in terms of

Financial Accounting is referred to as Historical form of accounting. In other words,

In practical circumstances Financial Accounting is more or less a legal requirement. In

Cost Accounting is operated with basically three objectives -

Presentation of information to enable the managerial decision-making.

Cost Accounting is not a legal requirement. Maintenance of cost accounting records is

As Cost Accounting is supposed to facilitate professional decision making on the part of

Financial accounting considers only those transactions which may be expressed in

As such, financial accounting and preparation of financial statements therefrom is no longer

Management Accounting is a service function which is concerned with providing various

Management Accounting involves the application of various special techniques and

Objects of Management Accounting

Presenting to the management the operating and financial statements at reasonable

Scope of Management Accounting

Accounting : It deals with recording, summarising and analysing various business

Cost Accounting : It deals with recording of income and expenditure, ascertainment

Establishment of plans or budgets for the future.

Comparison of actual performance with the planned or budgeted performance.

Computation of variations between the planned and actual performance.

Disadvantages/Limitations of Management Accounting

A very wide scope of management accounting is the limitation by itself. It attempts to

The installation and operation of management accounting requires a very elaborate

FINANCIAL ACCOUNTING AND COST ACCOUNTING COMPARED

Due to the various statutory regulations, maintenance of financial accounting records